3M (MMM) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M third quarter 2005 earnings conference call.

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

Afterwards will you be invited to participate in the question-and-answer session. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded Tuesday, October 18, 2005.

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

Good morning.

I'm Mark Colin, Director of Investor Relations for 3M, and welcome to our third quarter 2005 business review.

Before we begin I have a few brief announcements.

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

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 and our press release this morning list some of the important risk factors that could cause our actual results to differ from predictions.

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

Pat?

Thanks, Mark and good morning, everyone.

Let's begin with some opening comments on the quarter, turning to Slide Number 2.

This was an outstanding quarter for 3M.

Third quarter revenues were a record $5.4 billion, up 8.3% versus the same quarter last year.

Global currency growth, which is defined as volume plus selling price, was 7% for the quarter, with organic local currency growth of 5.6% and the CUNO acquisition adding 1.4%.

Every business posted year-on-year organic local currency growth led by Display and Graphics, Safety, Security and Protection Services, Consumer and Office, and Electro and Communications.

Our optical film business posted another record revenue quarter.

As we noted last quarter, growth in the LCD industry is accelerating driven primarily by demand for LCD television.

Turning to operating income, the third quarter represented the 15th consecutive quarter of year-over-year earnings and margin growth for 3M.

Operating income reached an all-time quarterly record of $1.3 billion, with operating income margin of 24%.

Our continued focus on corporate-driven initiatives and increasing sales volumes enabled to us achieve excellent operational performance.

In fact, this is the first time since we implemented our current organizational structure in January of 2003 that every business achieved operating margins of over 20% excluding the impact of the CUNO acquisition.

Reported earnings per share in the third quarter were $1.10, up 13.4%.

This is a penny above the top end of our previous guidance when you adjust for acquisition related costs.

During our integration process we were able to reduce our acquisition related costs from $0.03 per share that we estimated last quarter to $0.02 per share.

On August 2nd we closed the CUNO acquisition adding a valuable new liquid filtration customer base to our world-class separation and filtration technology platform and leveraging our broad geographic presence.

Integration and cost synergy goals are on track.

Sales growth and technology exchange work are underway, and the CUNO business is performing as expected.

Selling prices increased about 1% in the quarter, continuing the positive momentum from prior quarters.

Along with the benefits provided from our sourcing initiative, our pricing strategy this year has been key to our ability to maintain margins in the face of significant raw material price pressure.

In the U.S. our price growth was 2.9% year-over-year.

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

Adjusted for the price-down impact in consumer electronics related businesses, our international prices would have been up 30 basis points.

Free cash flow was 708 million including a special contribution of $300 million to the U.S. pension plan.

And finally, as you may have seen in the press release this morning, the board of directors authorized an additional $300 million for our share repurchase program.

This increases the total repurchase program authorization to $2.3 billion, leaving more than 500 million remaining for repurchase activity through January of 2006.

On Slide 3, we recap our third quarter sales performance on a geographic basis.

Worldwide local currency sales were up 7% in the third quarter.

Organic volumes increased 4.7% with acquisitions adding 1.4%.

As I previously mentioned, we continued our positive pricing trend with global selling prices increasing 90 basis points.

Year-on-year currency translation added 1.3% to third quarter sales.

Sales in the United States increased 6.8% as core volumes improved 2.1%, acquisitions added 1.8%, and price increases added 2.9% during the quarter.

U.S. organic sales growth was led by the Consumer and Office, Healthcare, Electro and Communications, and Safety, Security and Protection Services businesses.

Internationally, sales were up 9.4% in U.S. dollar terms.

Local currency sales increased 7.1%.

Core volumes increased 6.5% and the CUNO acquisition added 1.2%.

International selling prices declined 60 basis points in the quarter.

Selling prices continued to be impacted by our businesses serving the consumer electronics space where it's typical to trade off price for volume.

Currency effects boosted reported sales by 2.3%, driven by positive translation of 2.2% in Asia Pacific, and 9.5% in the Latin America-Canada region, while currency reduced European and Mideast region reported sales by 30 basis points.

In the Asia Pacific region, local currency sales increased 14.2% year-over-year.

The optical film business led growth in this region but the non-electronics related business were very strong with growth of almost 10%.

CUNO added 1.4% of local currency growth in the quarter.

In Europe, local currency sales grew by 2% including 80 basis points impact from acquisitions.

Growth in Europe was led by our Safety, Security and Protection Services, Transportation, and Industrial businesses, and was our best result since the second quarter of 2001.

The combined Latin America and Canada region had flat local currency sales in the third quarter versus last year.

CUNO added 90 basis points of growth in the quarter and we continue to see strong growth in certain businesses including Consumer and Office, Safety, Security and Protection Services, and Transportation.

As mentioned last quarter, growth in Latin America was impacted by the continued decline of our CRT rear projection lens business in Mexico and the move of our flex circuits customer from Puerto Rico to Singapore.

Without these two impacts and the CUNO acquisition, our local currency growth in Latin America and Canada would have been 4.8%.

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

As I previously mentioned, sales were up 8.3% year-over-year including 1.4% growth of acquisitions.

Gross margins were 51.1%, up 50 basis points over the third quarter of last year.

The combination of improved selling prices, mix, volume, factory efficiency and sourcing continue to more than offset the impact of higher raw material prices.

SG&A was 21.6% to sales, an increase of 50 basis points year-on-year, as we continue to invest in the emerging markets such as China, India, and Central and Eastern Europe.

The SG&A increase is also partially attributable to the CUNO acquisition as CUNO's SG&A runs somewhat higher than 3M due to its intense focus on building customer intimacy and providing superior service.

Research and development and related expenditures increased 4.7% year-on-year as we fund future growth for the Company.

As a percent of sales R&D was 5.5% versus 5.7% in last year's quarter.

Total operating income was up 9% to nearly $1.3 billion, with margins improving 20 basis points 24%.

Excluding the impact of the CUNO acquisition, operating income margins reached an all-time record high of 24.5% in the quarter with all of our businesses improving their operating income [inaudible].

The tax rate for the quarter was 32.5% which is 50 basis points lower than last year's comparable quarter but in line with our expectations.

Quarterly net income increased 10% year-on-year and earnings per share improved 13.4%.

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

Sales increased 1.7% versus the second quarter of 2005, led by gains in our Consumer and Office and Display and Graphics business.

Sequentially, operating income was slightly higher than the second quarter.

Operating margins declined by 20 basis points sequentially, impacted by the CUNO acquisition related costs.

Excluding CUNO completely, operating margins improved 30 basis points for a record 24.5%.

On a sequential basis both net income and earnings per share increased slightly.

Please turn to Slide Number 6 where we will examine our results by business segment.

In Healthcare, our core businesses including medical, dental, and health information systems was strong in the third quarter with approximately 8% local currency sales growth.

These very successful businesses, we are accelerating our investments in fast-growth areas including the alternate care segment in medical, digital dentistry, and in emerging markets.

Our strong core Healthcare growth this quarter was tempered by sales declines in two areas, personal care and related products, and legacy pharmaceutical.

In personal care, which is our diaper tape business, over the last year we have experienced significant price increases in certain key energy and petroleum-related raw material.

We were unable to pass through selling price increases in some product lines and elected to drive profits at the expense of volume in this lowest margin business in Healthcare.

Pharmaceuticals, sales in our legacy business, primarily prescription drugs in [inhalation], women's health, the cardiovascular, are declining due to price pressure in Europe and decreased demand for some of these older products.

We continue to generate growth in our Aldara pharmaceutical product which accounts for approximately 6% of total Healthcare sales.

Aldara sales grew in double-digits this quarter and growth outside the U.S. was particularly strong, over 18%.

However, sequential sales were flat.

In the U.S., physician adoption of Aldara has been slower than anticipated for the actinic keratosis indication.

Our sales and marketing efforts continue to focus on educating dermatologists about the significant advantages Aldara offers, including reduced recurrence over the well entrenched traditional treatment method.

Looking ahead for Healthcare we expect continued solid growth in our core medical and dental businesses.

However, we do expect the decline of personal care and related products in our legacy pharmaceutical businesses to persist into the fourth quarter.

Local currency sales in our Industrial business grew 12% in the third quarter.

With the CUNO acquisition whose results are included in Industrial added 8.3% of growth in the quarter.

Beyond CUNO growth was led by our industrial adhesives and tapes and abrasives businesses.

We continued to selectively raise prices to offset commodity, raw material price pressures.

Industrial continues to demonstrate very strong operational discipline as operating income grew 10.6% to $174 million.

Excluding the impact of CUNO operating income grew 18.4% year-over-year, and margins were over 20%.

Display and Graphics growth reaccelerated in the third quarter, increasing 7.9% in local currency as higher demand for LCD flat panel devices, particularly LCD TVs, drove record revenues of our proprietary optical films and components despite intense pricing pressure.

Our traffic safety systems business experienced strong growth as we saw renewed end market confidence in the United States following the signing of the new Highway Bill during the quarter.

We deliver solid growth in our commercial graphics business led by strong performance in the United States.

As mentioned in previous quarters, Display and Graphic sales were negatively impacted by almost 5% due to the continued decline of our CRT rear projection lens business along with a phase-out of our commercial videotape business.

Operating income in Display and Graphics increased 9.8% to $315 million.

Consumer and Office had a very strong quarter with local currency sales growth of 6.9% led by continued strong new product pipeline.

By combining unique functionality, along with customer-inspired design, the Consumer and Office team has revitalized growth in core products such as Scotch Tape, Post-It Notes, Filtrete, and O-Cel-O sponges.

Geographically growth was led by the U.S.

Operating income increased 14.2% to $171 million.

Electro and Communications local currency growth was 6% in the third quarter led by demand for our electronics products for the semiconductor fabs along with continued strong growth in our electrical products for insulating, testing, and sensing.

Heat sensors for automotive OEM air bag systems were a notable growth driver in the quarter.

This is Electro and Communications highest local currency growth since the first quarter of 2001.

Operating margins were a solid 21.2% in the quarter as operating income increased 37.5% to $127 million.

Safety, Security and Protection Services local currency growth was 7.8%.

We had broad-based growth across the business portfolio and geographies.

We experienced continued strong global demand for our personal protection products and solutions, particularly respiratory protection products, along with robust demand for our cleaning and protection products for commercial buildings.

Geographically growth was led by Asia Pacific followed closely by the U.S.

Profits improved by 13.3% year-on-year to $139 million.

And finally, our Transportation business continues to benefit from customer focused new products and productivity solutions driving third quarter local currency growth of 5.6%.

In our automotive business one growth driver has been paint replacement film, which is a superior alternative to using paint around car and truck windows.

This product enhances car styling while at the same time improves the auto manufacturer's productivity by reducing painting operations.

In our automotive after-market business the paint preparation system has increased the efficiency of painters in the body shop by shortening paint changeover and cleanup time while also reducing the use of solvents for cleaning paint guns.

Operating income increased 9.4% in Transportation in the third quarter to $114 million.

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

Net working capital turns were 5.5 turns or 5.6 turns excluding -- net working capital turns were in line with last quarter and up .2 turns versus last year's third quarter excluding -- capital expenditures were down versus the third quarter last year coming in at $208 million.

To date we have spent 660 million on capital expenditures and we continue to expect to spend approximately 950 million for the full year.

Third quarter free cash flow was $708 million.

This strong free cash flown enabled us to pay $321 million in dividends to our shareholders during the quarter.

We also bought back 624 million of our own stock resulting in a net repurchase of 444 million.

Including the 300 million increase in the share repurchase program we announced this morning, we have over 500 million left of our buy back authorization.

Weighted average diluted shares outstanding were 772.3 million down 3% from last year.

Our debt-to-capital ratio increased to 24.2% at the end of the third quarter due to higher debt levels as a result of the acquisition.

Please turn to Slide 8 where I will discuss our outlook for Q4.

Excluding the impact of the repatriation of foreign earnings under the American Jobs Creation Act of 2004 we now expect full year 2005 EPS to be 4.24 to 4.25 per share.

This raises the low end of our previous expected range which was 4.20 to 4.25.

For the fourth quarter, we expect earnings to be $1.02 to $1.03 per share an increase of 12 to 13% over last year.

Local currency growth is expected to be in the 4 to 7% range, excluding CUNO, which will add approximately two additional points of growth for the fourth quarter.

We expect sales growth in the fourth quarter to be broad-based among the businesses in our very diverse portfolio.

The hurricanes did have, have resulted in some very tight supply conditions and have significantly increased energy costs, fuel surcharges and prices for certain natural gas and petroleum related raw material.

During this very difficult period we have realized significant benefits through our sourcing initiative which has enabled us to substitute raw materials and reformulate where necessary to protect availability and minimize price impact.

Let me provide a quick update on the status of our CEO search.

Bob Morrison, our interim CEO, is on board full time and actively leading the Company.

The board has retained a search firm and is evaluating both internal and external candidates.

This quarter's high level of performance gives the board confidence they can take the time they need to select the right candidate.

Before we begin the Q&A let me summarize this outstanding quarter.

Consistent with our longstanding business model, operational discipline and broad contributions from our diverse portfolio drove record sales and operating income performance.

EPS improved 13.4%.

Operating income and operating margins improved once again, the 15th consecutive quarter of year-on-year earnings and margin growth for the Company.

All businesses achieved operating income margins of over 20% excluding the CUNO acquisition.

Driven by end market demand for flat panel LCD devices our optical film business returned Display and Graphics to a solid growth position in the third quarter.

As well as the CUNO acquisition integration is on track and our business teams around the world are energized to generate growth in this exciting new segment for 3M.

And finally, our board authorized an additional $300 million share buy back for the period through January of 2006.

We are very pleased to be able to deliver such an outstanding quarter and expect the businesses to continue at this very high level.

This concludes the formal part of today's call.

Joining Mark and me this morning are Matt Ginter, our Director of Financial Planning and Analysis, Bill Schmoll, our head of Tax and Treasury and Peggy Smith, our Chief Accounting Officer.

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

[OPERATOR INSTRUCTIONS] Please limit your participation to one question and one follow-up.

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

Your first question comes from the line of Robert Cornell with Lehman Brothers.

Good morning, everybody.

Good morning, Robert.

Yes.

Good quarter for Display and Graphics on the margin side.

I thought it was a great quarter for everybody, Robert.

Yes, it was a pretty good quarter actually across the board.

But my one question was a, what do you see with regard to, you know, market share issues in optical film?

Are you holding share?

Are you giving it back?

And also, maybe a comment on the performance of the new plants brought on line recently for the [DBEF] product.

Let me start with the last part of that.

The new plant should be delivering commercial products in the fourth quarter.

We're pleased with its progress on both quality and of course, as you ramp up you've got to continue to get at efficiency and cost but we're on track with the start-up of that new capacity down in Alabama.

On the share side of it, you know, we had a very solid quarter here.

We have a very strong leading position in the market.

We plan to hold that.

We'll continue to fight and maintain our fair share of the volume of the applications, and that's a day-to-day trade-off that we have to look at between price, volume and competition, but feel very strong about where our position is, and, you know, looks very good for the near future.

Just a follow-up, Pat, obviously the quarter is very good with the local currency growth.

I just wondered if you saw anything post-Katrina that suggested that some of the markets were softening post-Katrina and maybe any comment about what's going on in October.

I have not.

You know, from an end market standpoint, of course, our diverse portfolio you have some businesses that are maybe impacted more in the short-term, some less.

But all in all I have not seen a significant change.

Of course, the biggest change we've really seen is more on the energy related cost side of it, okay, which obviously we'll have see how that plays out, see if it stays in the market for a, if this is a short-term blip or stays on a long-term basis.

But from a volume perspective we're not seeing any real change.

Thanks, Pat.

Your next question comes from the line of Mike Judd with Greenwich Consultants.

Just a clarification.

The $0.02, did you take that out of the Industrial, or is that in the corporate or other?

I guess, Mike, the $0.02, you're talking about the one-time or the integration?

Yes.

That would have been embedded in the Industrial business segment.

Okay.

And then can you just remind us about the seasonality issues in Display and Graphics and Electro and Communications since those seem to be, you know, it's more of an Asian influence?

Well, you know, seasonality, I guess, if you take Display and Graphics, you almost to have split it for the break Display and Graphics down.

Optical film is not necessarily that seasonal out through what will be a big, we think this year a good LCD build going into the holidays.

But we think that that market segment will continue to grow, so that's probably less of a seasonal issue.

But when you do get into things like traffic systems and so forth, that business is more seasonal, or I should, I guess, more weather related, that when you do have cold weather or rain, those businesses are not as strong as during the nice weather conditions.

So it's a little bit different, depending which segment you're in.

Electro and Communications normally has a stronger mid part of the year and then they have a tendency to be softer the fourth quarter.

Again, part of it is weather related as it's just more difficult to do some of the work and repairs in the winter months.

But that would be the normal seasonality.

Thanks.

Congratulations on a good quarter.

Thanks, Mike.

Your next question comes from the line of David Begleiter with Deutsche Bank.

Thank you.

Good morning, Pat.

Very nice quarter.

Just on the pricing front, Pat, how much of this in the U.S. is passing through of higher raw materials and how much is sustainable, is more based on your value-based pricing initiative?

Well, you know, Robert, or, Dave, that's, we don't look at it necessarily as to ex amount that's driven by raw materials.

We, you know, a number of businesses, we have a, our market positional allows to us raise prices.

So we don't really look at it on that basis, but if it, if I kind of get maybe a little bit to the root of your question that this is a sustainable price for us.

We continuously monitor our competitive situation, and if we find out that our prices, you know, we can't command it in the market, obviously we'll adjust it accordingly, but right now we don't see any real pressure on that.

We have consciously looked at trying to get enough price, of course, offset some of the raw material pressures, which we've been able to do thus far this year.

And, Pat, just one more thing on Display and Graphics, you mentioned intense pricing pressure in Optical.

I think you targeted about a 3 to 5% price down every six months.

Has that increased or accelerated recently?

Well, you know, the story really has not changed significantly over time.

If you starting again with a premise that the OEMs are going to have to continue to drive price down in the end market to get volume, we will continue to contribute to make them as competitive as possible.

If you read some of their reports, at least the OEMs, they, of course, are, their financial results haven't been the greatest lately, so they, of course, are coming back to suppliers asking for additional price reductions.

Our strategy there is we want to maintain our volume in that business, we want to maintain our profitability in it.

We're not after margin, per se, so we will continue to, you know, kind of work at it to maintain what we can there.

Thank you very much.

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

Good morning, Pat.

Good morning, John.

Back to the pricing, you've been accelerating.

If you look at just U.S. pricing, which excludes really the optical business, we don't have to price down there, it was 2.2% in the quarter.

It's been going up 2 to 300 basis points accelerating each quarter through this year.

Is that going to continue?

Do you have price increases sort of on the table that were going to go up into the 3% range and maybe higher?

We were at 2.9 this quarter.

Just to be clear we're at, I believe, 2 last quarter, 1.7 the previous quarter.

Some of our price increases we did start at the tail end of last year in the fourth quarter so I do not expect that number necessarily to keep going up.

I think we've reached about the point to look at across the portfolio of I think about the price increases that we're going to have.

Now, you know, saying that, we also, of course, now have to relook at a number of our businesses around the potential impact the hurricanes have had in certain of our businesses to see what we're going to do obviously to maintain profitability of some of those businesses as they are going see higher costs and across the board on energy and surcharges and so forth.

So we'll have to keep an eye on that going forward but I don't see it escalating from here.

And then when do we find bottom in CRT and the videotape?

Well, the videotape, I believe, is out the first quarter of next year.

Is that right, guys?

I believe it's first quarter of next year.

That's kind of running out.

CRT will not go away.

CRT will be around.

I would say that it should have a diminishing impact as we go into '06.

That 5% impact then does it drop in half after the first quarter then when it's down to just CRT and not videotape?

I guess, let's review that again when we get into next year, John.

Okay.

Thank you.

Your next question comes from the line of Mark Gulley with Soleil Securities.

Good morning to everybody.

I wanted to go over this decontenting effect, Pat.

You talked about the fact that on the monitor side in LCD that the contenting has hurt your sales growth.

We see that as your sales growth is certainly less than other people like Corning that are selling service-related materials.

So is the decontenting effect still occurring in monitors?

Mark, we're having a little hard time hearing you, but I think the gist of your question is around contenting in monitors.

Right.

Is that correct?

That's correct.

Same situation.

You go back to all of the LCD panels, flat panel issues.

Everyone in the segment right now is after a price, you know, significant price-down pressure.

Some people have opted to try to go to lower cost optical solutions, or lighting solutions for monitors, in some cases they've tried to place with us competitive product all together.

We feel, again, very good with our value proposition in that space, and we'll try to hold on to that as much as possible.

But we just have to keep working with all the manufacturers to make sure that the design-in where we can make good money.

Looking forward, Pat, could the decontenting effect that is lesser films, fewer cost films, fewer films, could that also occur in LCD TV as well?

Let's face it.

I can't, I'm not the OEM, and they will eventually decide how they want to design their units.

Remember that the LCD industry is projected to grow at about 45% compound annual growth rate.

Never said that we'll probably be 45% with them.

I think we may grow half of what they grow at.

But that's fine with where we're at.

So we'll have to just constantly look at and trade, you know, see what the profitability of that business is.

We remain very, very close with all the manufacturers, make sure that our products are designed in, and we can continue to add the right value proposition for them.

Okay.

Thanks.

Okay.

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

Good morning.

Couple questions.

First of all, on the Healthcare you seem to have a little bit of a difficulty getting the growth in that business up into, you know, consistently into mid to high single digit range perhaps, and maybe it has potential to go higher.

You talked about personal care and the competition in generic drugs impacting you.

Should we look forward to this business being a mid single digit performer in the future until Aldara or the next generation of IRM drugs becomes a bigger part of the portfolio?

Are you doing something right now to improve the performance of that business?

I think that's a good question, Dmitry.

As we try to kind of indicate, the medical, dental, health information systems, when I say dental it includes our dental plus ortho businesses, we do see those as being very, very good performing businesses.

You have a situation in personal care which is, it's a reasonable size share of the Healthcare business, which unfortunately in the very near-term will continue to drop off from the top line.

We're doing a lot of work to see if we can't regain some of that business as long as it's got the right kind of profitability for us.

So it will have a drag for a while in that business.

So we mentioned that we will see it ongoing into the fourth quarter.

I think we'll still see it as we go into '06 as well.

And the Aldara is 6% of the sales of Healthcare.

So even if you do the math, its growth rate would have to start to ramp up very dramatically to start the change the overall growth rate of Healthcare that much.

So like it or not, we probably are in a more of a single digit growth rate for Healthcare in the near-term.

Okay.

Thank you.

Just a follow-up on that, I think it was last year or the year before, I forget, but you wrote down a good portion of the drug development and drug delivery business and contract manufacturing business within Healthcare.

Is there a need for further restructuring of the segment or are you just going to ride out the weakness that you're seeing in a couple of your businesses currently and hopefully get new products and spur of the growth of some of the other businesses?

Well, on the drug delivery side, which I think was the core of your question, that business is very, it can be kind of peak and valley depending upon our contracts.

Right now, we're in decent shape, we're in the process of trying to negotiate some additional business here in the fourth quarter, and that will determine if we have to take any additional action there or not.

Okay.

And then a question on LCD sell-through.

I understand that sell-in in the third quarter has been pretty strong, but growth at store level seems to be up month-over-month basis in kind of the mid high single digit.

Is there a danger of building inventory in the fourth quarter that will have to be corrected and affect your growth either in the fourth quarter or the first quarter if the store-level sales don't pick up, or am I reading too much into this?

That's obviously hard for to us read because I don't know what the OEM or the retail's plans are for holiday promotions and so forth.

It's always a risk in this industry, but the forecast that we're getting from the manufacturers would indicate that at this point in time they're not concerned about that.

Okay.

Thank you very much.

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

Hey, Pat, nice quarter.

Good morning, Robert.

Thank you.

Couple of questions.

Can you give us any kind of sense of, and I know it's tough, but where you are in terms of hedging any of the commodities like natural gas, when your contracts roll over, what the outlook is there, and also anything that's going on in terms of the currency, what the currency hit was in this quarter and what that looks like going forward?

Okay.

Start with your currency question.

The currency impact is starting to become less, you know, less and less.

Our analysis would indicate it's probably order of magnitude of $0.04 year-over-year this quarter.

If you get to the hedging question on commodities, we do have a hedging program for natural gas, and that's a, kind of a two-pronged strategy, Robert.

One is, our overall hedging is in the, we try to keep a hedging of 40 to 60% of our exposure and it's hedged two ways.

One is in some cases we actually have escalation agreements with some of our customers related to natural gas prices, where natural gas is a high percentage cost of our processing cost.

As an example, industrial minerals would be a good example of that.

And then for the rest of it is operating needs for natural gas and so forth, we do hedge that, but on a combined basis we're probably in about a 50% hedge position right now.

I have to tell you, a year ago I thought I was a fool when we hedged at that level with natural gas prices at $5.

Now, you know, it's going to play out quite well for '06.

And hopefully we see somewhat of a retraction here in the spike of natural gas so we can live through, and our hedging will pay off for the year.

So you think you're hedged right through '06?

We're pretty well hedged.

As a matter of fact, we've got some hedges into '07/'08, but obviously at a lot smaller levels.

But we're about 50% hedged into '06.

Great.

And then just one other question.

You mentioned, I think, or Mark did at the beginning of the call, that business, you guys are continuing to execute terrific operational excellence, and that's given the board, you know, a feel that they've got plenty of time here.

That's one way of interpreting it.

The other way of interpreting it could be is, hey, you guys are doing great, why not go for an internal candidate, which would seem, given the amount of time here, that maybe the board isn't really looking at.

I was just wondering if you could give any sense of why you think the board feels they've got to go outside of the Company at this point?

Well, I guess to answer your question, Robert, I didn't say they think they have to go outside the Company.

What we've said from the beginning here is what the board wants to do is to take the appropriate time to look at both internal and external candidates.

Just because, you know, time's going on doesn't mean that they're focused exclusively on an external candidate.

So, you know, they're going to take the time necessary to look at the available people on the outside, even get to know some of the people better inside that they already knew, and, you know, look at those versus the outside options and make the right choice.

Our advice to them is we think the day-to-day operations of the Company are performing very, very well.

Bob's in here on a full-time basis, where we need is help and guidance, he's a very active participant in leading the Company, but we really don't have a driving need, okay, to make a decision on a premature basis.

Have there been any major decisions in terms of acquisitions or anything of that sort that have been put on hold because of the process?

No.

Positively not.

All the things that we as a leadership team have developed plans around are continuing full speed ahead.

Okay.

Great.

Thanks a lot, Pat.

Thanks, Robert.

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

Good morning, Pat.

Good morning, Jack.

Just doubling back to Display and Graphics, you had indicated that the sales gain was trimmed by 500 basis points because of CRT.

Can you give us a comparable number for operating income?

And then just secondly, I was unclear with regard to the LCD portion of display whether margins were up, down, or flat.

Offhand, I don't have that number, Jack.

We can follow-up with you on what that impact was on the --

Comparable to the 5%.

Comparable 5%.

As a matter of fact, the guys are looking it up here, so if we get it we can get it to you.

I'm sorry, the other piece was on optical?

Just on LCD, I think you made the comment, Pat, that you, maybe I'm overstating it, you're less concerned with margin to retain share or something like that.

I mean it [inaudible] sounded like margins were down in LCD film even though it looked like the revenue has turned pretty nicely.

I mean, let's face it, this is a big business for us.

Our goal there is not a margin goal.

Our goal there is how do we participate in as much volume, as much profitability as we can.

If that translates into a higher volume, higher profitability and a lower margin level, that's probably going to be the right trade-up for us.

But it's hard to exactly articulate a formula that says, you know, where that trade-off is going to be.

Okay.

And in their pricing kind of leverage when they deal with you, I mean, is one of the comments that, you know, another major competitor, which has been rumored for the last year or so might be coming into the market, I mean, do they hold that over your head or is that not an issue?

Let's face it, Jack, no OEM wants to be completely dependent on a supplier.

Our goal with the OEMs is to continue to make sure that they understand our value proposition versus others.

I would much rather start with where we're at, which is our existing position, than having to try to come sell against us.

Been rumors out there for some time about certain competitors coming in, but we haven't seen it play out yet in real volume [inaudible].

Okay.

Just one follow-up.

In the past I think there have been questions about 3M being underlevered.

You add some debt for CUNO, and now you have net debt of 1.4 billion, which free cash flow will erase over a relatively short period of time.

Can you just share your thoughts with us looking forward over the next year or so, is there a potential for the stock buy back to be significantly larger in the next 12 months or starting January of next year, than it has been in the last 12 months?

Well, you know, go to the stock buy back, our authorization, we've just increased it to $300 million to 2.3, which I think is a very, very hefty buy back program.

We will, you know, as we always do, review proposals with the board on a going forward basis.

I can't really say right now if we'll do more or less than we did this year.

Good.

Thank you.

Hey, Jack --

Yes.

On the OI impact the guys say it's about 9.5% each point.

So OI would have been up 18% rather than 9ish?

Right.

Your next question comes from the line of John Inch with Merrill Lynch.

Thanks.

Good morning, Pat.

I want to understand your pricing commentary with respect to optical films.

You're basically suggesting that pricing, if I read what you said, did not deteriorate this quarter versus the trend you've seen traditionally.

Is that the way to think about it?

I would say that's up through this quarter that is true.

Okay.

Pat, is there any way to quantify what, because you called out the Highway Bill, what impact you think the Highway Bill had or could have to the D&G segment?

I guess off the top of my head, John, I can't say.

It's a little bit of, I think you look at the first half of the year where our business wasn't as strong.

You see the third quarter coming back a little bit.

There's kind of a timing issue, but I wouldn't be modifying your models significantly there for the impact.

But it is definitely more positive than it has been over the last probably month or so.

But it is material, is what you're saying, it's just not necessarily a huge driver.

It's not material to the Company, no.

But material to the segment?

Well, it's material to traffic, of course.

Probably not material to the segment as a whole.

Okay.

Then just, you know, kind of final question here.

You guys have been successfully raising price, I'm just curious if you've run any kind of internal analysis that looks at the trade-off of how much revenue you may be giving up because you've been raising price.

Have you guys thought about that and maybe it might help us think a little bit about incremental profitability versus the volume trade-offs associated with price increases?

John, of course, in a business like ours with so many different kind of businesses, so many different customers and so many different market positions, coming up with a generic answer to that's [inaudible] difficult.

We really to have look at our pricing on a product-by-product, customer-by-customer, segment-by-segment basis.

Constantly look at where we're priced, vis-a-vis competition, what the right price volume trade-off is in the marketplace, so you know, that's kind of a market perspective.

Then, of course, you've got the other perspective of what's happening from a cost pressure standpoint that you have to look at at the same time.

But it really is a segment-by-segment approach that we have to look at, and thus far, I would say that other than the businesses we've talked about, as an example, personal care, where we consciously, we had to raise prices and therefore we lost some business, I can think of a handful of businesses where that has happened.

In cases where we've raised prices, have we had some, you know, volume declines?

The businesses would say no.

So I have to believe on the margin we probably have in some cases, but I have to tell you, we're a lot better off to have taken the price increase and now we can continue to look at the segments and how we want to compete in those, and if we have some more volume opportunities through pricing we can go after them.

Okay.

That obviously begs the question.

Other than [tapes] that you called out, I mean if it's not enough to perspectively quantify the price increases why wouldn't you raise, given the high contribution associated with it, why wouldn't you raise prices that much more and test the resistance of the market to get your profitability up even further?

John, I mean, again, it's a very fine line.

There's very few segments that we don't have strong direct competitors in that we just can't unilaterally try to say, let's go, you know, take our prices up and risk all kinds of volume to competition.

Our issue is not margins, okay, in this business.

We're running 24.5% margins in the Company if you back out the CUNO acquisition this quarter.

We're taking, in some cases a, you know, thinking about how do we become a little more aggressive on the growth side of the business.

We don't need to continue to expand margins, okay, we need to get both growth, continue to drive productivity, and if that holds margins, so be it.

But we're not off to just try to take price for the sake of pricing if there is an opportunity, we will definitely go for it.

Understood.

Thanks, Pat.

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

Hey, Pat.

I'm trying to get an outlook on, you basically gave one for the fourth quarter, and to get to your typically conservative number you would need obviously some significant seasonal slowdown, but I want to check that with your comment on Display.

For it to get to 103 you've got to have Display going down a lot sequentially, unless some other divisions come down a whole lot.

So maybe a little more clarification to go from 110 to 103 sequentially is indeed, you know, is Display going to drop a lot?

Well, Display as a segment will drop.

Again, the traffic business has a tendency to have a slower fourth quarter than they do the third quarter.

A number of our businesses have a tendency to be slower in the fourth quarter than they are in the third.

So that as I think you're aware, that's kind of our normal history, is what the trend of our businesses are.

Now, I expect optical film will continue to grow somewhat, okay, in the fourth quarter, but I think it will be offset by probably some other drags.

E and C, I mentioned previously, normally has a slower fourth quarter than they do the third quarter.

Safety, Security has a generally a slower fourth versus a third with some of the businesses that they're in as well.

So all in all, revenue probably is down a little bit sequentially.

The other way to think of it, Jeff, is our EPS guidance is 12 to 13% for the quarter year-over-year.

And I guess that's the context that I put it in.

We expect to be at 13 for the year.

Fourth quarter, 12, 13 seems about the right range to forecast the business as I see it today.

And just another follow-up on that.

The fourth quarter '04, how would you characterize that environment back then?

I think we're looking at an easy comp in Display but were the rest of the businesses doing pretty well, best of your memory here.

Yes, it wasn't bad.

Consumer had a very good fourth quarter last year, but Display was softer if you recall last year, so on a business by business basis, it's a little bit different.

Just trying to look back to the fourth quarter.

It looks like obviously Industrial and Consumer were very strong on the income line.

On a business-by-business basis it's a little bit different, but I think you'll see when we kind of report that Consumer will have a tough comp, E and G will have a little bit easier comp than they had last year with that business and so forth, but, you know, net-net I expect something that's in the 4 to 7 guidance that we [inaudible].

Thank you.

And lastly, Pat, on the CEO, I heard you loud and clear.

I know you can't comment further, but would it, in your view, behoove the internal workings of the Company to have someone in place for the January strategic planning sessions?

Well, we are in the middle of our, I'll call it our operating plan and process right now.

I don't see that that's at all a detriment to the process.

We have a tendency to review our strategic plans more in the spring-summer time frame, because when they actually come together we do start the process, you know, more after we get the operating plan done for the year, but the board and the leadership of the Company are well aligned as to what the objectives of the Company are.

Bob's here on a full-time basis, helping to drive the programs that we had already established, modify some of them a little bit, probably a little more growth orientation than we had in last year's plan, so that's where we're at.

Great.

Thanks a lot.

Okay.

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

Steve, please proceed with your question.

His question has been withdrawn.

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

Good morning, Pat.

Just a quick question.

Your Consumer and Office business continues to put up some pretty solid numbers and it sounds like, at least from what you were saying today, a lot of that's coming out of the U.S.

Can you speak to what you're thinking about in terms of maybe increasing the global marketing budget for that business so that you can actually use some of the new products and some of the strength of your brand in the U.S. to kind of grow that business internationally?

John, did Mona Zary call you and ask you to ask that question?

No?

Okay.

If you look outside the U.S., you've got two different kinds of worlds.

In the emerging markets, now is absolutely the right time to be investing in a lot of the brands that we have.

Some of the brands are maybe a little higher end for some of the economies today, but you have to repackage them and reposition them from a price and content perspective to make them work, but we have some great products that can fit in emerging markets and now is the time to try to get the brands well established there.

Europe is a tougher one for us.

It's much more of a private-label market.

The margins aren't as good in Europe, and we continue to try to work to find a better solution for our business in Europe.

Obviously we don't have it exactly figured out today.

One of the real drags in Europe these days is our visual systems business, which I think you're well aware of with the gold analog business, which is the overhead projector and supply business, which was a big part of our European Consumer business.

That continues to drag some.

But we will continue to invest outside the U.S. on the Consumer business.

And it really is an investment.

It's not necessarily an immediate pay back.

But we have to keep investing in those businesses is for the long-term.

Okay.

And then in Asia, you had said ex electronics, you were up 10%.

Yes.

Can you give us a flavor for where the real strength of that came from or was it across the board?

It's really clearly across the board.

You start with China.

China is growing at about 30%, which China has to be.

They are the beneficiaries of one heck of a lot of local market growth as well as export content that's coming out of China these days, so our China business has to be expanding at those kind of rates.

Japan grew at 5% for the quarter, and I think all but Industrial was up for Japan.

So very good solid business in Japan for the quarter as well.

So it's quite broad-based, but China is, of course, a very big piece to that.

Was there one specific division of yours or a number of divisions that really saw the strength, or, again--

It was, it pretty it was across the board.

You really to have look at it country-by-country.

Some performed better than others, but it was pretty well across the board performance.

Thanks a lot.

Okay.

That concludes the question-and-answer portion of our conference.

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

Again, thanks for joining us this morning.

The team at 3M is highly energized and we're committed to delivering our plans for the fourth quarter, and we'll talk to you again in January.

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

You may all disconnect, and thank you for participating.