3M (MMM) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

Thank you for standing by, and welcome to the 3M second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded, Monday, July 18, 2005.

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

Please proceed.

Good morning.

I'm Mark Poland, Director of Investor -- [ Inaudible ] Business review.

Before we begin, I will have a few brief announcements.

As in prior quarters, today's discussions will follow a series of Power Point slides which are currently available on our investor relations website.

Looking ahead our third quarter 2005 earnings call will take place Tuesday, October 18th.

Please mark your calendars accordingly.

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

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

The MD&A section of our most recent Form 10-Q and our press release this morning list some of the important risk factors that could cause actual results to differ from our predictions.

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

Thanks, Mark, and good morning everyone.

Let's begin with some opening remarks on the quarter.

Please turn to slide number two.

This was another very good quarter for 3M.

While sales were slightly below expectations, operational discipline and broad contributions from our diverse portfolio drove all-time record quarterly sales and operating income performance.

Our second quarter performance affirmed once again the ongoing vitality and the broad-based strength of 3M's balanced business model.

The 3M's team ongoing focus on operational excellence continues to pay off, delivering outstanding results in the quarter for six of our seven businesses posting double-digit operating income growth.

Operating income margins in the second quarter reached an all-time record coming in at 24.2.

3M finalized plans in the second quarter, which were announced on July 1st, to reinvest approximately $1.7 billion of foreign earnings into the U.S. pursuant to the American Jobs Creation Act of 2000.

The Act provides the company the opportunity to tax effectively, repatriate foreign earnings for U.S.-qualifying investment specified by our domestic investment.

As a consequence of the second quarter of 2005, we recorded a non-recurring cash charge of $75 million debt of available tax credits.

Reported earnings per share in the second quarter were $1.

Excluding the impact of the tax charge, the company achieved earnings per share of $1.09, a 12.4% year-over-year increase, resulting from a combination of local currency growth and the operational improvements I just mentioned.

Second quarter revenues were a record $5.3 billion, up 5.6%, versus the same quarter last year.

Local currency growth, which is defined as volume plus selling price, was 3.5%, as we had six of seven businesses post year-on-year local currency growth.

We have confidence that we can build on our progress today and look forward to continuing solid performance for the remainder of the year.

Turning to a few of our growth platforms.

The LCD optical film business again posted record volumes in a much more competitive environment.

The LCD industry's growth, driven primarily for demand by LCD televisions, is expected to accelerate in the second half of this year and our film business is well-positioned to meet this demand.

Our proven business model, characterized by strong customer relationships, proprietary manufacturing and quality processes, and leading economies of scale, continues to provide us a competitive advantage.

In healthcare, local currency growth in the second quarter was tempered by two main reasons.

A slowdown in the growth rate of our Aldara pharmaceutical product, and the impact of increased pricing and competitive pressures in personal care and related products.

They are driving profits at the expense of volume in our personal care business as we strive to improve the profitability in the lowest margin business in healthcare.

After achieving two new approvals for Aldara in 2004, we directed many of our sales and marketing resources over the last year squarely at the [atinacartosis] and digital cell carcinoma indicators.

We believe this focus may have led to a temporary slowdown in prescribing for our legacy genital wart indications, which is seasonally strong in the second quarter.

Aldara continues to represent a significant opportunity for us, to change the way patients are treated for AK and BCC, two very common and serious diseases.

We continue to work hard to educate doctors and patients on the long-term benefits of Aldara as we know revolutionary therapies like these take time to gain client acceptance.

To intensify our marketing efforts, we just launched a advertising campaign to raise the public's awareness of skin health and the solution provided by Aldara.

If you have not seen the ad on television, you can view it on our website at www.aldara.com.

I will provide further details on these business segments' second quarter performance in our segment discussion later.

Our pricing strategy continues to gain traction in Q2 with an 80 basis point improvement.

Our U.S. price performance of 2% comes on top of 1.7% in the first quarter.

As in past quarters, our international price performance was negatively impacted by our businesses that serve the consumer electronics market.

To be adjusted for the price down impact in our businesses that serve the consumer electronics industry, our international prices would have been up 40 basis points.

Let's now turn to slide number three.

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

Worldwide local currency sales were up 3.5% in the second quarter, slightly short of the bottom end of our 4 to 7% guidance range, primarily due to a shortfall in our Healthcare and Display and Graphics business.

Global volumes increased 2.7%, but selling price is up 80 basis points.

This is the strongest selling price performance since the first quarter of 2002.

Year-on-year currency translation added 2.1% to the second quarter sales.

Sales were up 4.5% in the United States, as volumes improved 2.5%.

We continued our first selling price momentum as selling prices increased 2% during the quarter.

U.S. sales growth was led by our Consumer and Office;

Safety, Security and Protection Services;

Transportation; and Industrial Business.

Internationally, the sales were up 6.3% in U.S. dollar terms.

Local currency sales increased 2.9%, driven entirely by volume.

Currency effects boosted sales by 3.4%, driven by a positive translation of 3% in Europe, 1.9% in Asia Pacific, and 9.3% in Latin America and Canada.

Local currency growth was 5.6% in Asia Pacific, with Japan down slightly, and the rest of the region up almost 10%.

Asia Pacific local currency growth in the quarter was very broad-based, but was led by Electrocommunications followed closely by Consumer and Healthcare.

In Europe, the local currency growth was 70 basis points in the quarter versus last year.

As we expect the softness in western European economies to continue for the near future, we continue to drive productivity programs and move resource to higher growth businesses and geography.

We posted almost 1% local currency growth in the combined Latin America and Canada region.

We saw a strong double-digit growth in our core businesses in the second quarter, led by Consumer and Office, Transportation, Security Services, and Industrial.

This growth was partially offset by the continued decline of our CRT reel projection business in Mexico as manufacturers convert to new television technologies, and the manufacturing relocation for flexible circuit customer base from Puerto Rico to Singapore.

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

All of my comments exclude the impact of the tax card.

As I previously mentioned, sales were up 5.6%, year-over-year.

Gross margins were 51%, consistent with the second quarter of last year.

The combination of improved pricing, volumes and efficiency continue to offset the impact of higher raw material prices.

SG&A was 21.2% of sales, a 40 basis point improvement year-over-year, driven by incremental sales leverage and the continued focus on cost discipline.

Research and development and related expenditures increased 1.7% year so far as we fund future growth.

Total operating income was up 8.2%, to nearly $1.3 billion, with margins improving 50 basis points, 24.2%.

Six of our seven businesses improved their operating income margins and also achieved double digit operating income growth, excluding the impact of the tax charge, the tax rate for the quarter was 32.5%, which was down 50 basis points versus last year's comparable quarter.

For the remainder of 2005, we expect the tax rate to remain at 32.5.

Including the impact of the Act, we expect our full year 2005 tax rate to be 34.

Quarterly net income increased 10.2% year-on-year and earnings per share improved 12.4%.

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

Sales increased 2.5%, versus the first quarter of 2005, and five of our seven businesses posted sequential dollar increases.

We leveraged this sales increase to 4.9% operating income.

Operating margins improved by 50 basis points sequentially, driven by a combination of improved pricing and a continued focus on productivity and cost discipline.

On a sequential basis, net income increased 5.2% and earnings per share increased 5.8%.

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

Healthcare sales exceeded $1.1 billion, up 3.8% in local currency.

Sales growth in the quarter was broad-based, led by our Medical, Orthodontic, Drug Delivery and Health Information Systems business.

Our Personal Care Diaper Tape business was negatively impacted by competitive pressures and our pricing actions.

Boosting the overall healthcare growth by nearly 1%.

Operating income was $310 million, or 27.9% to sales.

This represents a 13.2% increase versus the second quarter last year.

Moving to Industrial, local currency growth was up 4.1%, versus the same quarter last year.

This growth was led by our Industrial Adhesives and Tapes, as well as Abrasives businesses.

Operating income grew 20% to $189 reflecting continued pricing traction and focus on driving productivity.

Display and Graphics local currency sales declined 2.5% versus the second quarter last year for a number of reasons.

First, coming off a greater than 18% local currency growth in Q2 of '04, driven by an inventory build in the LCD channel, the LCD business experienced very tough comparisons but nonetheless achieved an all-time record volume.

Secondly, we experienced softness in our traffic safety business with highway projects in the U.S. awaited funding from the long-delayed highway bill.

Third, continued economic weakness in western Europe and Japan impacted our commercial graphics business.

And finally, sales and operating income were negatively impacted by over 3% and 6% respectively, due to the phase-out of our commercial videotape business along with the continued decline of our CRT rear projection lens business.

We are driving productivity in our CRT projection business by aggressively reducing structural costs, as the rear projection TV market is shifting to micro-display TV's.

At the same time, we are investing in promising micro-display products and technologies to meet the shift in end-market demand.

Looking ahead, we anticipate that increased global demand for flat panel displays, particularly LCD TVs, will improve the second half sales of LCD enhancement films and fuel higher growth in our Display and Graphics business.

Profitability of the Display and Graphic business remains very strong, with operating income of $277 million, or over 32% of sales.

Consumer and Office local currency grew by 6.7%, driven by strong new products.

This is Post-It Super Sticky, Scott Stretchy tape, Scotch tape with a new contoured dispenser, and cleaning products for the home.

Growth was broad-based across many channels that we serve, most notably in the mass market consumer and home-improvement retail channel.

Geographically, growth was led by the U.S.

Operating income increased 13.8%, to $140 million.

Our Safety, Security and Protection Services business local currency growth was 7%, in the quarter.

Sales growth was broad-based, driven by global demand for personal protection solutions, due to the continued success of protection products from our Hornell acquisition, along with cleaning and protection products for commercial buildings, roofing granules for residential asphalt shingles.

Operating income improved by 11.5%, to 151.

Electro and Communications local currency growth was 1.5% versus last year, led by a demand for specialty adhesives and tapes, the electronics market, along with electrical products for insulating testing.

Strong operational focus and portfolio management in our Electrocommunications business drove a solid operating margin of 20% in the quarter as operating income improved almost 33% to $118 million.

And finally, local currency growth was 6.7% in our transportation business, with operating income of 15.6% versus last year.

Sales growth was broad based led by businesses that serve the automotive OEMs and body repair shops.

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

Working capital terms were 5.6, an improvement of .2 turns versus one year ago and flat sequentially.

Inventories increased by $80 million versus last year or 4.1%, inventories were up million dollars sequentially.

Accounts receivable were up $38 million or 1.3%, versus the second quarter of 2004, and were up $52 million.

Capital expenditures were flat versus the second quarter of last year, coming in at $217 million.

To date, we have spent $452 million on capital expenditures out of our full-year expectation, 900 -- [ Inaudible ]

Second quarter free cash flow was strong at $951 million.

This strong cash flow enabled us to pay $323 million in dividends to our shareholders during the quarter.

We also bought back $514 million of our own stock, resulting in a net repurchase of $422 million.

For the remainder of 2005, we have approximately $872 million available in repurchase authorization.

Weighted average diluted shares outstanding were $780.2 million, down 2.4% from last year.

Our debt-to-cap ratio declined to 15% at the end of the second quader as we retired a maturing debt instrument.

We expect our debt levels will again increase in the third quarter as a result of our anticipated acquisition.

Please turn to slide eight where I will discuss the outlook for Q3 and the remainder of 2005.

Excluding the impact of the American Jobs Creation Act of 2004, we expect full-year 2005 EPS to be within a range of 420 to 425 per share, including approximately four cents per share earnings dilution from the CUNO acquisition.

This raises the low end of our previous expectation of $4.15 to $4.25 and represents a four cent increase from the first quarter guidance.

Local currency sales expected to be in the 4 to 6% range for the year.

We expect accelerating second half growth due to a strengthening growth rate, driven by demand for LCD TVs and continued performance from our broad portfolio.

Both the currency guidance excludes the impact of -- [ Inaudible ] For the third quarter, we expect earnings to be very similar to the second quarter, with earnings per share of $1.09 to $1.11, excluding the impact of the CUNO acquisition.

Excluding a 3-cent impact from the transaction-related costs associated with the acquisition, we expect EPS to be in the $1.06 to $1.08 range for the third quarter.

Our local currency growth is expected to be in the 4 to 7% range, excluding -- [ Inaudible ]

Let me provide a quick update to the status of our acquisition of CUNO.

The company has obtained all regulatory approvals for the transaction.

There will be a shareholder meeting on the morning of August 2nd with the CUNO shareholders to vote on the acquisition.

Pending shareholder approval, the closing of transaction will happen shortly thereafter.

In the meantime, integration teams from both companies are working on building integration plans so that when the transaction closes, we can hit the ground running to enhance CUNO's already strong track record.

Before we begin the Q&A, let me summarize what I consider a very good quarter.

While sales were slightly below our expectations, operational discipline and broad contributions from a diverse portfolio drove record sales and operating income performance.

Margins have improved to a record 24.2%, to 14th consecutive quarter of year-on-year margin expansion for the company.

EPS improved 12.4% and we generated almost $1 billion in free cash flow.

This was another quarter where our balanced operational excellence and organic growth-driven business model produced solid results.

This concludes the formal part of today's call.

Joining Mark and me today are [Mac Guinter], our Director of Financial Planning and Analysis, Bill Schmoll, our Head of Facts and Treasury, and Peggy Smyth, our Chief Accounting Officer.

We'd be happy to address your questions so let's begin our q-and-a.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of John Lynch with Merrill Lynch.

Thank you.

Good morning, Pat.

Good morning, John.

On the display and graphics business, the commercial piece of it and the rear screen television business, did the -- the volumes were they up sequentially or was there any sort of growth rate slowing -- perhaps a little bit more color.

Well, the reported local currency growth was 2.5.

If you back out the business we are exiting and the rear projection business, that was three points and we are slightly positive in the quarter of half a point.

And was that -- what was the trend, though in the quarter, Pat?

And do you think that's indicative of what you are expecting?

Why should volumes improve in the second half?

Well, if you go back, John, to last year, in the second quarter, specifically as we talk about the L.CD business right now, there was -- we were reaching a -- kind of a peak in our performance.

There was some inventory build in the LCD channel in the second quarter and if you recall, there was then a correction that occurred in the third and the fourth quarter last year.

So if we look at all the data that's out there we anticipate a very strong second half from the LCD manufacturers and we are very well-positioned to play into that.

So that's the biggest probably change from -- if you look at the second quarter by itself, versus if you look at the back half, back half of the year.

Just easier comps?

Well, easier comps, plus you have a very significant build rate, specifically in the TV market, at the back half of the year and so the combination of those two should yield us better performance for the back half of the year.

And then just as a quick follow-up, you didn't mention the search for the CEO.

Could you perhaps just frame out the expectations of the timing?

I mean, should this be an event that occurs in 2005, and perhaps, what -- what kind of a pedigree are you looking for from this individual?

Someone with an operations bias, growth bias, a healthcare bias?

How should we be thinking about this?

John, first of all, I think it is very difficult to ever give a precise timing on -- you definitely -- Bob Morrison who is here on a -- you know, running the business is very engaged in the business.

I do not know exactly the pedigree that the board is looking for for the individual.

So that's -- you know to determine the exact timing of this, I guess is going to be very difficult.

But Bob is actively engaged in the company.

Focused on the people, as well as our growth of the company and when we select a new CEO, we'll make that handoff.

But in the meantime, we have our plans in place and we're executing to them.

Thanks, Pat.

Thanks, John.

Your next question comes from the line of Jack Kelly with Goldman Sachs.

Good morning, Pat.

Good morning, Jack.

Just to follow up on the LCD business.

It is my understanding that the rate of change in LCD film growth -- I'm talking dollars now -- reached low ends in the fourth quarter, and in the second quarter, the rate of change year-over-year got up to maybe 8 to 10% so maybe a little bit of an acceleration.

If we go to the second quarter, are we saying that that 8 to 10, if that was right, is now negative?

Or is it's -- it was low?

I'm just wondering why things changed in the second quarter.

Because I would have thought things would have improved incrementally year-over-year.

Well, Jack, we did have, you know, record volumes of shipments in the quarter.

The competitive nature of the LCD business is -- is intensifying.

As the L.CD manufacturers are bringing on more and more capacity there's far more pressure on price bound activities which in some cases there are some manufacturers who are deciding to look for alternate solutions in some cases where they are making a tradeoff between performance versus -- versus cost.

I think if you looked at some of the items recently from the LCD manufacturers.

They had a relatively poor second quarter.

They have a fair amount of pressure to drive costs out as they try to drive down the end market pricing as well.

So we -- you know, we -- our business model -- remains very, very solid.

We think we've got the technology leadership position, we've got quality supply capabilities.

We're in with all the manufacturers, but the reality is there's some shopping going on, looking at alternate solutions for LCDs right now.

So it sounds like maybe the pricing got a little worse than that 10 to 12% that we had been seeing.

I mean, I know the overall margins for the group improved, but --

The pricing is difficult in that space, because every product has kind of a unique pricing structure.

But pricing did not change materially in the second quarter.

Okay.

Good.

And just -- the second question.

Just a little more color on the diaper tape business.

They said you took some actions.

Yes.

Let me -- the diaper tape business is one of the businesses that got hurt abnormally with raw material price increases.

Consequentially, we've had to deal with some price increases to our customers which in some cases means that we've had to -- or, you know, we lost some business there but we had to do it for the profitability of the business.

Okay.

Thank you. -- And your next question comes from Michael Judd with Greenwich Consultants.

It looks like the prices for petrochemicals and plastics are swinging back up in the third quarter and can you just talk about actions that you guys are taking to pass through those higher prices, please?

Thank you.

Well, we'll -- we'll see if prices do come up relative to our own products.

We've actually seen a slight moderation most recently from our side, but we continue to remain very focused on the raw material input side of the equation, and what we need to do on our pricing side.

We probably still have a little room to go on -- on pricing, but we'll -- we have to look at it on a business-by-business basis, an industry-by-industry basis to see what's going on.

But we -- we are on top of that.

It's, you know, very hard to predict but our business is -- we have to make those decisions really on a business-by-business basis.

But we are on top of that.

As I mentioned, we have seen a slight moderation in the commodities that we're buying, but we'll keep our eyes on it.

Any further questions?

Michael?

Thank you.

Thank you, Mike.

We now go to the line of David Begleiter of Deutsche Bank.

Thank you.

Good morning, Pat.

Good morning, Dave.

Pat, in LCDs, I'm looking for a more competitive marketplace but still looking for a stronger back half of the year, can you just tie those two together?

Well, I think they are very closely linked.

Because to get higher volumes, the LCD manufacturers, of course, are trying to drive down end market pricing.

That's how they get -- that's how they get volume.

Therefore, it requires them to look back in their value supply chain and either they continue to take the cost out to get to their end market pricing and keep the profitability up.

So, of course that puts more pressure back on the supply -- the supply base, and you can do that either through -- obviously just pricedown or continue cost down efforts.

In many cases some of them are looking at alternate technologies and in some cases alternate films that we feel are not to the same performance characteristics that are ours and in some cases they are making that value tradeoff to drive, you know, cost out of their unit.

So that's -- you know, I think there's a direct correlation between the growth in the -- especially the LCD TV market, as well as the whole electronics side of it, as well as the cost down -- you know the cost down pressure.

People just keep looking for ways to get costs out of their product.

And, Pat, just on your overall pricing strategy, in the U.S., of that 2% price increase, any way to quantify how much was a pass-through of raw materials and how much was more on a value-based pricing and how long can this value-based pricing initiative gain traction and add to the top line?

Well, it's not -- we have to look at pricing as a holistic sense here, it's not just raw materials.

And it's hard to differentiate between the two of them.

Basically, what I can say is we are recovering, at this point in time, our raw material increases.

But we continue to look at this, you know on a day-by-day basis where we can get the maximum leverage.

Thank you, Pat.

Thank you.

Your next question comes from the line of Dmitry Silversteyn with Longbow Research.

Good morning, Pat.

Good morning, Dmitry.

Question of taking a step back looking at your original guidance for the top line growth of mid to high single digits and not getting there in the first half of the year.

What were the differences between your expectations heading into the year and what we saw.

Is it entirely related to the display graphics and the consumer and office segment in the first quarter of the year or are there some other issues?

With that in mind -- you addressed it piecemeal -- but can you just summarize what you expect in the second half of the year to get better, whether it's end markets performing better or internal execution doing better to get to what looks like what needs to be north of 5% growth in the second half of the year to average even the low end of your guidance for the year?

Yes.

Dmitry, I guess a couple of pieces.

First of all, we expect most of our businesses to continue to accelerate their performance from the first half to the last half, with the exception of, you know, one or two businesses that have a little more seasonality, first versus second half of the year.

But Display and Graphics is the one that's going to have to help take the rate up to where we had it, and that's what -- you know the back half of the year, that's in our internal plans.

We always had the Display and Graphics as being a higher goal in the back half of the year versus first half of the year.

And I think the other thing, to be frank with you guys is that pricing, you know, the whole impact of raw materials and pricing and so forth, has definitely impacted us to some -- to some degree.

It impacted the consumer business in the first quarter, as I mentioned earlier on personal care.

So to some degree that's not going to be an excuse though, because we want to try to drive price where we can, and, you know, every point of price we get is worth probably about two points of volume if you look at it from a profitability standpoint.

We want to make sure that we are optimizing that equation.

But if you look at, you know, over time, second -- you know, first half to the second half, we are seeing improvements in most of our businesses, with the biggest change being in display and graphics.

Okay.

If I could ask a follow-up question.

Specifically on display and graphics there's a couple of businesses in there that obviously make the growth of the overall division look worse than it is relative to the films business.

How long is it going to take for you to get to the size that you want those businesses to get to?

In other words, exit the business to the extent that you want to exit, and is there a -- some sort of an impairment charge or something we should look for down the line to reflect those businesses being permanently impaired?

I guess to answer the last part of your question first is I do not expect any kind of impairment charge.

The commercial video business is -- probably run six months to run out.

The CRT business is continuing to decline.

There will be some business there, of course, for a period time that won't go away.

I think completely.

We're in the process of trying to become a much more cost effective manufacturer in that business, we have moved some of our businesses to China to get a much more cost-effective source.

That will not go away completely, but it -- it has eroded quite a bit in the last year or so.

But that will be -- in the last year or so but that will be there for quite sometime.

But I would think that the comps will be easier, you know, for the next year or so.

Okay.

Thank you.

Thanks.

Your next question comes from the line of John Roberts with Buckingham Research Group.

Good morning, Pat.

Good morning.

When you say that LCD customers are using lower performance films to get their costs down, are they using lower performance 3M films and therefore it's affecting your mix or are you losing business in that performance downgrade that customers are doing.

Well, there's a combination of factors going on.

In some cases they are de-contenting us, which means less of our film in some of our products but they are also going to others for turning films, whereas they are offering lower costs but in our view also a significant performance tradeoff.

And we continue to work with each one of the manufacturers to make sure that they understand, you know, at least from our perspective, you know the value -- the value equation that they do offer.

But there are some competitive films in the marketplace.

And are you saying you are not doing streetfire pricing or tiering your business to be able to compete with that?

We have not taken -- okay, to be the bottom base pricing, whatever to hold on to business.

Our business model is very much of a technology leadership position, a -- we think a superior product performance, but when I turn around and at the same time say that we always have pricing flexibility.

If we -- if that gets to be what we have to do, we'll, of course, take a look at it.

But at this point in time that's not our strategy.

Our strategy thus far is to maintain, what we think is a leadership position, relative to a technology performance aspect of films, and we'll just have to see how it sources out to see if the other film manufacturers and the LCD -- you know, makers are satisfied with that performance over time.

Thank you.

Your next question comes from the line of Steve Tusa of JP Morgan.

Good morning.

Good morning, Steve.

I just wanted to switch gears to Healthcare.

Where did Aldara finish the quarter from a growth perspective?

I think the first couple months were up mid to high single digits and then the outlook for the rest of the year, you know, I think you had 25% growth in that business in the second half, and, you know, how does that kind of -- of '04, how does that play into your guidances?

Did you expect, you know, the growth rate in the second quarter to be maintained in the second half of year, or how is the outlook there?

Well, Steve, the growth rate for Aldara in the second quarter was more of a single digit number for us, which is sort of our expectations, which, you know, going into, it we knew that we had a steep ramp-up here.

We've been working on this direct-to-consumer campaign to get more awareness to the consumer and more work, of course with the [DIRMS].

And that will continue on.

My own expectations are that is will take a while for this to catch on.

So I would expect the growth rate to improve a little bit as we go to the back half of the year, but it will take us awhile to get to the 20% plus rate.

Just remind me of what your longer term targets for the current indications are, and are you, you know, pushing those out a little bit or are those at risk or is this a near-term blip.

We see it as a near term blip.

We have not changed our view of what the ultimate potential of the IRM platform is at all.

So our view hasn't changed.

It's just that we think it's going to take more work to try to get the marketplace educated through the -- you know the performance.

The performance of this, because it is -- you know, it is a great -- it's a great drug but, you know, it has to work its way through the value equation with DIRMS and consumers to make it -- you know to make it work.

There are 10 million AK customers in the U.S. alone so there's a definite need for a solution.

We just have to get both the consumer and the DIRMS convinced that what we are offering is the right -- the right solutions, which I think clinically has been proven to be the best solution for AK.

Okay and then R&D contributed 20 basis points to the year-over-year margin improvement.

Do you -- do you see that -- you know, do you see an increase in the R&D in the second half of the year?

Just remind me what the annual target as a percentage of sales for R&D.

We do not have a specific target percent of sales.

What we have been doing, Steve, the last couple of years is R&D has been up a little bit on a year-over-year basis.

I expect the same thing to be true this year.

Our focus in R&D is identifying the right projects and if we have the right projects we'll allocate resources to it.

But we are moving money between our businesses to make sure we're -- you know, we're focused on the right alternative.

So we don't have a specific objective but we are working on allocation of resources as well as the efficiency of our R&D effort as well.

And one more quickie.

Just 4X, how much did that contribute from an EPS perspective and with the recent strength in the dollar, you know, how did that play out for the second half of the year?

What are your assumptions in your guidance there?

Well, our assumptions are that we -- we fall to the rate at the end of the quarter that's what we -- we use for our guidance going forward because we don't want to speculate where the rate is going to go.

Relative to the second quarter, it's about 3 cents impact on the EPS basis, and if rates stay where they are at, that will, of course, diminish over time in the Q3 and Q4.

I think we are currently looking at Q4 as a crossover point, about break even.

Great.

Good quarter.

Thanks.

Your next question comes from the line of Jeff Cianci of UBS.

Hi, Pat.

I'm trying to understand the margin.

Actually it looks like it's improving here.

And if I back up, it appears you are making a conscious choice in a lot of businesses to take, you know, high margin business as opposed to low margin business.

In other words, walk away from volume.

So that's going to be with us for sometime, I presume.

So is it not better to assume, you know, a lower end sales growth end of the range, maybe a higher end margin?

Am I getting that direction right?

And as a result, do you think we can hold something close to the 24% margin going forward?

Well, Jeff, you know, we don't forecast margin.

I guess you can kind of back in.

If you look into our -- if you look at our old local currency growth assumption and what we give you EPS-wise.

You know, normally, Q3/ Q2 are relatively similar performance.

So I just don't want to get trapped.

Q4 is usually a falloff from Q3 so I don't want to exactly promise what that's going to be at this point in time.

But the original observation is correct.

From the standpoint of -- you know, I think there was partially a window of time, when a lot of these prices were up significantly the first part of the year, tailing last year.

Where I think you had to -- had you to try to take the price -- the price move.

Our strategy has been, let's take it where we can.

You can always come back on a selective basis and bring prices back down if you need to.

But if you don't get them up in the first place, it's pretty hard to bring them -- you know, bring them back down.

So that's been our strategy and as you indicated, you know, we have foregone some businesses because of, you know, that move.

But strategically we are better positioned going forward on that -- on that basis.

And I guess the observation on, you know, the low end, we have continued to drive the business to the goals that we had -- we had set.

But as you know, we run the business model on the basis this we can give you, you know, solid returns even if we are at the lower end of that range.

Okay.

Thanks.

And I missed an answer you had earlier to the CEO question.

Did you say this would be possibly a third quarter or fourth quarter event?

Or did you not say.

Jeff, I think you probably heard the answer, didn't you?

But that's okay.

I did not -- you know, it's -- you know, it's virtually impossible to speculate.

I guess you can speculate if you want, but we don't know how long that's going to --

Right.

It will take.

We want absolutely the best candidate and if that takes longer, so be it.

Important is that we are focused on delivering results here.

We're not -- you know, we're not sitting around waiting for that to happen.

Bob is in the seat helping to lead the company today, so, you know, that's -- it's not -- it's not a big deal for us.

Okay.

Thanks.

The next question comes from the line of Robert Ottenstein with Morgan Stanley.

Pat, the electronics margins were incredibly strong.

I was wondering if you could give us a little detail in terms of what -- I guess it is [Joe Harlin] running that business.

What are they doing over there?

Yes, it is Joe -- Joe is down in Austin now.

And you are right, you know, 20% margin in that business, I will be honest with you, when I first came to the company, I would have hoped for, okay, getting 20% margins in that business and they have achieved that.

There is a combination of things.

One is the electrical business, the electrical products business remains very, very strong.

We have cost discipline in that business in the last couple of years under Brad's leadership down in Austin too.

So we have done a good job of getting cost out.

We have realligned the portfolio a little bit to eliminate some of the lower profit businesses we have there.

We also did move, I guess to be fair, is we did move the electronics markets, the product group there the first of the year.

So they probably helped the margin a little -- a little bit because they are slightly higher margin -- higher margin business but that was the right business combination for us and we moved them out of industrial and down into Austin.

But they are doing a marvelous job.

They dealt with the cost issues they had when the volume was very soft.

Now they are starting to get some volume back, which kind of shows the significant leverage you can have with cost discipline and, you know, a little bit of volume recovery.

Okay.

On the -- on the Corning precision lens, I'm hearing, I guess, that that business continues to disappoint a little bit.

Is there the possibility of a charge there?

Not that we anticipate at this point in time.

Now, part of the reason we acquired that business was to access some of the technology they had, which will lead to some of the microdisplay products that we hope to get to the market.

So you know there's two prongs.

One is they have existing business, which was the CRT or the projection business but they also had some technology embedded in it that we felt would be helpful to try to commercialize and get to the market in microdisplay, which we knew was going to be the future.

This just happened about two years before we had anticipated the technology conversion.

And then just one final question, Pat, on the LCD films, in terms of the new lower quality low-cost competition, is that on the BEF side or the DBEF or would it be films that you wouldn't even classify as either but do the same thing and how are these other films -- I mean, are there patent issues here?

Just a little more clarity there, please.

These would be on the BEF side, not the DBEF side, which I guess DBEF would be multi-layer and BEF would be micro-application film.

These will be more on the micro-applicational alternative side, which are not as technologically sophisticated products, that others are manufacturing, particularly Asian manufacturers.

The largest of which is LG Electronics, is making some of their own film.

But it's more on the -- about the lower performing side of the film mark.

Great.

And can you just give us a rough idea if -- I mean last year sales and the optical film were $1.5 billion, what -- what the spread would have been between BEF and DBEF?

We have never give than split out, Robert.

And it's hard because we're constantly re-engineering the products and as a matter fact we have a product in the market today that's a combination of the two films.

So the marketplace -- you know the marketplace is changing.

The new capacity, though that we're putting in down in Decatur is for the DBEF products, the multi-layer product, which is one of the products that is more used in the LCD TV.

Thanks a lot, Pat.

Your next question comes from the line of John McNulty of CSFB.

In your healthcare business and particularly tied to the Aldara business, with the big ad campaign it looks like your sales force is pushing heavily on two areas and left the general awards area behind a little bit and so maybe you are adding sales there.

Should we be thinking about the profitability of this business throughout the rest of the year, dipping down as you put more investment into it and then expect, you know, make the margins of profitability to return in '06 or can you hold up the margins where they are now?

I -- if I look at healthcare in total, John, I think we're okay with the margin -- the margins we have.

Within pharma, you know the campaign we are running is not a -- unusually expensive campaign and effectively in that business you spend far more in R&D than you do in sales and marketing.

So I wouldn't get too overly concerned about the margins -- the margins there.

We are going to continue to spend what is appropriate to try to get the growth rate to the level that we feel we need to get it at.

But we think we've got -- if you look at it from a portfolio healthcare perspective, I think we're -- we're reasonably okay with kind of the margin structure that we have there.

Okay.

Great.

Thanks.

Your next question comes from the line of Bob Cornell with Lehman Brothers.

Yeah, good morning, everybody.

Good morning, Bob.

A couple of questions.

In the 4 to 6%, you know, guidance local currency over the balance of the year, how much of how much of that is price?

I guess just to be clear, Bob.

It's 4 to 6 for the whole year.

Right.

4 to 7 for the third quarter.

I just -- I just want to make sure, you know, I got the facts right with you guys.

Price is -- we did .8 in the second quarter.

I would expect something similar, maybe slightly higher in the third quarter is my current -- my current thinking.

And generally, you know, no one has asked, about you know, the whole 3M acceleration effort, new product pipeline.

Organic growth has been below what people thought the first half of the year, I think you made the point that you are doing the volume price tradeoff, but still with the whole acceleration effort, you would have, I would have expected better core volume growth.

What is the perspective there on the new product acceleration issues and the new product pipeline?

The view has not changed materially since the February meeting that we had in New York, acceleration pipeline still looks -- still looks the same.

You know, one caveat there, of course is that a big piece of that pipeline is around the two products that we spent some time talking about -- the LCD film and Aldara sales.

Aldara -- we think we have a plan to get that up.

The sales ramp-up and then LCD film is -- you know is a big piece of the acceleration growth as well.

And we feel very good about our -- our position there.

So, you know, those two really haven't changed, and, you know, the rest of the products and the other five businesses continue to develop very well.

You know, you can say, well, okay, why -- you know, why is the growth rate not there as much?

I don't think it's as much the new products that aren't quite catching on as -- as you said, we've got some price tradeoffs.

Price volume tradeoffs were taking in the marketplace that's going on.

A few spots in the world, that the economies are not performing, you know, quite the way we had thought we would.

Specifically, you know, western Europe remains very sluggish on us, and Japan remains somewhat slow.

You know, all in all, our acceleration, our new product pipeline is as good as it was back in February.

We continue to resource all the -- all the good ideas that we have in there, so nothing has really changed.

You know, you didn't say specifically but, you know, is GE now emerging as one of the players in the prism film?

Well, I have seen their announcements.

I've not actually seen their product or seen it at shows or anything.

But as we check with what the LCD manufacturers are doing and who they are specking in, we are not seeing GE show up at this point.

My own personal comment is Aldara works but it did leave a mark on my arm.

I hope to see you next time and see how well you are doing with it.

Amen, bro!

Gentlemen that concludes the question-and-answer session of our conference today.

At this time, we will turn the conference back over for some closing remarks to our management from 3M.

Okay. dod Thanks.

And, again, thanks for joining us this morning.

The team is energized and committed on delivering our plan, and we won't miss a beat as we are out selecting a new CEO.

So thanks and I look forward to talking to you on the third quarter call.