3M (MMM) 2005 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M fourth quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] We will now turn the call over to 3M.

Thank you.

Good morning, everyone, and welcome to our fourth quarter and calendar year 2005 business review.

I'm Mark Colin, Director of Investor Relation for 3M.

Before we begin I have a few brief announcements.

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

Our first quarter 2006 earnings conference call will take place on Thursday, April 20.

Please mark your calendars accordingly.

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.

Our press release this morning, and the MD&A section of our most recent form 10Q, lists some of these important risk factors that could cause actual results to differ from our predictions.

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

Pat?

Thanks, Mark, and good morning, everyone.

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

This quarter we have several new items to discuss, including a accumulative effective accounting change related to FIN 47, effective stock option expensing on our financial results and an update on our pension status.

In addition, George Buckley will share some of his initial perspectives on 3M and I will wrap up the call with our 2006 guidance.

And, of course, we will leave time for your questions.

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

Please go to slide number two.

Q4 was another great quarter for 3M and wraps up another very successful calendar year.

Focusing on the year for a moment, our 2005 performance again demonstrated the operational strength of 3M and the value of the diversification of the 3M business portfolio.

We generated solid top-line growth which accelerated during the year.

Our sourcing organization and the businesses work together to maintain customer service, while successfully managing the business to avoid supply disruptions in the face of hurricanes and shortages of many key raw materials.

We increased our dividend 16.7%, the 47th consecutive year of 3M dividend increases, and we repurchased 2.3 billion in stock.

In fact, through the combination of dividends and stock buyback, we return a total of 3.6 billion to shareholders during 2005.

And we completed the acquisition of CUNO, now a standing liquid filtration company, which adds to our greater than $1 billion filtration platform.

Finally, we welcomed George to the company in December and you will hear from him later this call.

I will talk in more details about the calendar year later, but overall 2005 was an outstanding year for 3M.

Moving on to the quarterly results, the fourth quarter was also characterized by broad base contributions from our diverse portfolio.

We recorded particularly strong results in our businesses that served the industrial, safety and electronics related markets.

Our performance this quarter demonstrated the value of 3M's innovative products, which brings to customers and the suburb capability of 3M organization to overcome the headwinds of raw material price inflation.

In the fourth quarter we achieved record quarters sales of $5.3 billion, up 4.6%.

Local currency growth, which is defined as volume plus selling price, was 7.3% for the quarter with organic local currency growth of 5.2% and the CUNO acquisition adding 2.1%.

Foreign currency translation turned negative in Q4 and reduced sales by 2.7%.

As reported by the Consumer Electronics retailers, end market demand for LCD televisions was particularly strong during the holiday season, which drove our optical film business to an all time record sales revenue.

Operating income increased 11%, reaching a fourth quarter record of $1.2 billion.

Fourth quarter operating income margin was 22.8%, among the highest of our peers and a testament to the unique technology and value that we continue to bring for our customers around the world.

Reported earnings per share in the fourth quarter were $0.99.

Included in this result is the adoption of FASB interpretation number 47, the accounting for conditional asset retirement obligation.

During the fourth quarter, 3M reported a non-cash charge of $35 million after tax as a accumulative effective change in accounting principle.

This charge represents conditional asset retirement obligations associated with 3M long-lived assets.

Under FIN 47, we now all recognize the cost of restoring our long-live assets, such as our mineral quarries, reusable condition over the life of the asset instead of upon disposal.

Excluding this impact, which was not included in our prior guidance, the company achieved earnings per share of $1.04 for a 14.3% year-over-year increase.

Free cash flow was almost $900 million in the quarter.

Return on invested capital was 23.7% for the year, more than double our cost of capital and up 30 basis points from 2004.

Our strong ROIC is driven by our unique business model, focusing on innovative products and solutions that provide very high value to our customers, leveraging a shared global asset base, along with the continued focus on improving productivity and standardizing business practices across all businesses and geographies.

Also we announced that beginning January 1st of this year, we realigned our Industrial and Transportation businesses into one unit.

This new business combination leverages common markets, channels and customers, technologies, manufacturing facilities and selling processes.

This combination will provide additional efficiencies which will be reinvested into growth.

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

Please remember that our results by business segment, which I will detail in a moment, are more indicative of our underlying performance since we manage our businesses globally and record sales where customers are, not necessarily in the region where the final product is consumed.

On a worldwide basis, we again exceeded 5% organic growth.

Worldwide sales in dollar terms increased 4.6% versus last year's fourth quarter.

Volumes increased 7.2%, with core volumes up 5.1% and CUNO adding 2.1%.

Volume prices were essentially flat versus last year.

This previously mentioned year-on-year currency translation reduced sales by 2.7 percentage points.

In the U.S. in the fourth quarter, we had positive benefits of pricing and the CUNO acquisition, however U.S. organic volume growth was slightly negative.

I will expand on this shortly in the business segment discussion.

Our international sales were up 8.8% in local currency terms.

Volumes increased 10.7%, including 1.3% from the CUNO acquisition.

Organic local currency growth was 14% in Asia/Pacific, with the CUNO acquisition adding 1.8%.

In Europe, local currency growth was 4.8%, our best results since the first quarter of 2001, with organic local currency growth of 3.6% and an additional 120 basis points from CUNO.

In the Latin America and Canada region, organic local currency growth was flat and CUNO added 1.2%.

The Latin America, Canada region continues to be impacted by two unusual circumstances.

One, our flex circuit's customer moved their business from Puerto Rico to Singapore.

Two, defining volumes in our CRT rear projection lenses business.

The combination of these two items reduced local currency growth by 4.2% in Q4 for the region.

International selling prices decrease by 1.9% in the quarter, impacted by our businesses that serve the Consumer Electronics market where price/volume tradeoffs are an integral part of doing business as volumes continue to rise.

Currency effects reduced year-over-year international sales this quarter by 4.5%, driven by a decline of 8.7% in Europe and 3.8% in Asia/Pacific.

Currency effects added 6.3% in Latin America and Canada sales during the quarter.

On slide number four, we detailed the P&L compared with the fourth quarter of last year.

Fourth quarter earnings per share were $1.04, up 14.3%, versus last year's fourth quarter excluding the previously mentioned 35 million after tax impact of FIN 47.

Operating income increased 11% to 1.2 billion and margins improved 130 basis points to 22.8%.

This improvement was mainly driven by higher volumes, [fixs] improvements and productivity.

Gross margins were 50.8%, up 2.1 percentage points from last year's fourth quarter.

SG&A expense was 22.1% of sales, an 80 basis point increase year-over-year.

The increase is primarily due to an approximately 30 million pretax, or $0.025 per share, charge in connection with the settlement agreements of one of our pending [with pages] follow-on class actions and two individual follow-on actions all involving direct purchasers of transparent tape.

We will provide further details in the legal proceedings discussion in the MD&A section of our 2005 10K.

We also continue to invest in growth programs and brand building throughout the portfolio as a means of stimulating our growth rate.

Research and development related expenditures increased about 5.1% year-on-year, as we continue to invest in growth for the company.

As a percent of sales, R&D was 5.9%, unchanged from last year's fourth quarter.

During the quarter, we reclassified certain patent related costs to research and development and related expenses from SG&A, due to the increasing financial significance of our patent process to our overall R&D efforts.

These patent costs include patent filing, professional and maintenance fees.

The amount of the fourth quarter reclassification was 14 million in 2005 and 13 million in 2004.

And the full year reclassification was 57 million in 2005 and 51 million in 2004.

Fourth quarter net income was 796 million, a 10.5% increase year-on-year.

Slide number five details our performance by business segment.

I have often mentioned to you the value of having a diverse portfolio businesses and this quarter's results are a great example of this.

As compared to some prior quarters, you saw a wider spread in performance as four of our businesses leveraged local currency growth of approximately 10% into even higher operating income growth.

In our Health Care business, total fourth quarter 2005 local currency sales were disappointing, as they are approximately the same as last year, while operating income was down 1.7% to $304 million.

Operating margin wasn't a very solid 28.3% of sale.

Similar to last quarter, our quarry Health Care businesses, including medical, dental and orthodontics, grew solidly in the fourth quarter with local currency sales growth of approximately 5.5%.

However, overall growth in Health Care was tempered by sales declines in three areas, personal care related products, drug delivery, and pharmaceutical.

As we have mentioned in previous quarters, the personal care diaper closure business continues to experience significant price increases in certain key energy and petroleum related raw material.

In the very competitive diaper business, we have been unable to raise our prices sufficiently to cover raw material inflation and have given up some volume as a result.

We are responding to this with new products that we believe will make us more important to our customers.

Products that leverage core 3M technology strengths in non-woven materials and proprietary adhesives and we are working hard to recover volume over time.

Sales declined in our drug delivery systems business in the fourth quarter due to a tough year-on-year comparison.

In last year's fourth quarter, we booked large orders of CFC-based aerosol components in inhaler fills.

Looking ahead, on the more strategic non-CFC side of the aerosol business, our partner, Sepracor, launched Xopenex in the first quarter of 2006.

This is manufactured by 3M.

We expect Xopenex manufacturing revenue to be an important growth driver for DDS into the future.

Our pharmaceutical business was impacted by a manufacturing interruption for our Maxair auto Inhaler product that forces a temporary pull the product from the market.

These manufacturing issues have been resolved and the product is now back on the market.

We also experienced a sales decline in our woman's health product, MetroGel-Vaginal, due to a competitive marketed product and we now expect that there will be a generic substitute for MetroGel-Vaginal approved in mid-2006.

The combination of sales declines in these two products impacted total Health Care sales by about 2% in the quarter.

Our Aldara pharmaceutical product continues to be one of the largest dermatology products globally.

However, year-over-year local currency sales declined for the first time since we launched the product in 1997.

We continued to experience growth in Aldara outside of the U.S. but sales in the U.S. declined slightly in the fourth quarter.

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

It has become clear our sales for the AK indication will fall short of our expectations at the time of FDA approval.

We are currently re-assessing Aldara's total market potential.

Looking ahead in Health Care, we expect continue solid growth in our core medical and dental businesses, as we continue to invest in fast growth areas such as the alternate care market in medical, digital dentistry, and emerging markets.

However, we expect the declines of personal care related products and our branded pharmaceuticals business to persist throughout 2006.

Local currency sales in our Industrial business grew 18.2% from the fourth quarter.

CUNO acquisition, whose results are included in Industrial, added 12% to growth in that segment.

Beyond CUNO, growth was led by the continued demand for our industrial adhesives and tape.

During the fourth quarter, we continued to selectively raise prices to offset raw material price pressure.

Industrial continues to demonstrate strong operational discipline, as operating income grew 32.9% to $188 million.

Excluding the impact of CUNO, operating income grew over 27% year-over-year and margins were almost 20%.

Display and Graphics growth was very strong in the fourth quarter, increasing 10.2% in local currency, as seasonal demand for Consumer Electronics, particularly LCD flat panel televisions, grow record revenues of our proprietary optical films and components.

Price declines in LCD films accelerated moderately in the fourth quarter, reflecting continued intense price pressure on LCD component manufacturers and our strategy to drive volume growth by maintaining attachment rates in this very rapidly growing market.

Moving to our traffic safety systems business, local currency growth was nearly double-digits in this quarter, continuing the positive growth momentum from the third quarter.

As mentioned in previous quarters, it's plain graphic sales operating income continues to be negatively impacted by the decline of our CRT rear projection lens business.

ERT negatively impacted the ENG sales and operating income by 4.1% and 11.7% respectively in the fourth quarter.

We expect the drag from the CRT rear projection business to ease in the second half of 2006.

Operating income in Displaying Graphics increased over 17% to $281 million during the quarter.

In Consumer and Office, fourth quarter sales were 754 million, or up slightly local currency terms, as compared to an exceptionally strong fourth quarter of 2004 when sales increased 8.3%, as several large retail customers apparently bought aggressively to meet their objective.

We saw positive local currency growth in our construction home improvement, home care, and protective materials businesses.

However, the continuing decline in our visual systems business impacted both sales and operating income by approximately 2% during the quarter.

Looking ahead to the first quarter, we expect Consumer and Office local currency growth rate to return to historical levels.

Fourth quarter operating income was down 2.6% versus last year's fourth quarter, at $143 million.

Sales in Electro and Communications were 585 million, or up 10.9% in local currency terms.

This result was driven largely by outstanding growth in Consumer Electronics, for our products solved the unique needs of our diverse and globally electronics manufacturing customers.

We also had excellent local currency growth in our electrical markets business, where we offer an array of insulating, testing, and sensing solutions to the electrical utility and infrastructure industry.

This is Electro and Communication's highest local currency growth since the first quarter of 2001.

Operating margins were a solid 19.7% in the quarter, as operating income increased almost 37% to $115 million.

In Safety, Security and Protection services local currency sales grew almost 10%, driven by continued strong global demand for our personal protection products and solutions, particular respiratory protection products.

Strong volume growth in our roofing granules business and slight to price increases to offset raw material and energy costs.

Geographically, local currency growth was led by the U.S.

Profits globally improved by 20.9% year-on-year to $130 million.

And finally, our Transportation business delivered local currency growth of 3.3%, despite challenges in the U.S., the OEM Big Three automotive market, along with lower levels of distribution buy-in due to cash flow tradeoffs by customers in the automotive after-market business.

Transportation's operating income in the fourth quarter increased 1.6% to $100 million.

Let's now turn to slide six for some financial highlights for the calendar year.

Sales increased 5.8% to 21.2 billion, with organic local currency going to 4.1% and acquisitions adding 100 basis points for the year.

Our growth rate improved during the second half of 2005 and, for the year, all seven of our businesses post a positive local organic local currency growth.

Our optical film business sales growth accelerated throughout the year, posting record revenues in 2005.

In August we completed the acquisition of CUNO, which adds to our existing $1 billion plus filtration platform.

Earnings per share for 2005 were a record $4.26 per share, an increase of 13.6% versus last year, excluding special items in 2005.

Operating income increased 9.4% to $5 billion with all seven businesses posting profit increases.

Operating margins increased to 23.7%, an 80 basis point improvement versus 2004. 2005 economic profit, which is defined as after tax operating income less a charge for operating capital, was $2 billion, excluding special items in 2005 which was up 11.3% versus 2004. 2005 free cash flow was a strong $3.3 billion, similar to our 2004 level.

We returned a total of $3.6 billion during the year to our shareholders, with a combination of 2.3 billion of share repurchases and 1.3 billion in dividends.

All in all, 2005 was a very good year for 3M.

Slide number seven depicts our 2005 calendar results on a geographic basis.

In the U.S. sales grew 4.9% for the year, an organic local currency growth of 3.5% and an additional 1.4% coming through acquisition.

Organic growth was led by our Consumer and Office, Industrial, Safety Security and Protection Systems, businesses, as well as Electro and Communication.

Operating income was up 10.3% in the United States, to $1.3 billion.

European growth was slightly positive in 2005, with organic local currency growth up slightly and acquisitions adding 60 basis points.

Local currency growth improved in four of our businesses, namely Safety, Security and Protection, Transportation, Health Care, and Industrial.

Operating income was 1.1 billion up 5.8%.

Organic local currency growth in Asia/Pacific increased 9.8% in 2006, with all businesses contributing positive growth.

Acquisitions added 80 basis points to growth in Asia/Pacific.

Operating income was 2.1 billion, a year-on-year increase of 11.7%.

Latin America and Canada's organic local currency growth increased 0.8% with an additional 50 basis points coming via the CUNO acquisition.

The movement of our flex circuits customer from Puerto Rico to Singapore, along with the decline of our CRT rear projection business, impacted full year growth in the region by 4.1%.

Operating income was 519 million, increasing 7.5% versus last year.

On slide number eight, you will see some of the balance sheet and cash flow metrics for 2006.

Networking capital turns were 5.7, or 5.8 turns if you exclude CUNO.

Turns were up 0.2 turns from last quarter and flat with last year's fourth quarter, excluding the impact of CUNO.

Inventories increased by 265 million, including a 56 million from CUNO versus last year.

Inventories were up 3.1% sequentially.

Currency translation effects reduce inventory by 89 million year-on-year at 16 million sequentially.

Accounts receivable increased 46 million year-on-year, including $88 million related to CUNO.

Excluding CUNO, receivables were down 1.5% year-on-year and down 7.3% sequentially.

Currency translation effects reduced accounts receivable 231 million year-on-year and 91 million sequentially.

Capital expenditures were 283 million in the fourth quarter, bringing the full year total to $943 million, in line with our expectations.

Fourth quarter free cash flow is $888 million versus 999 million last year.

However, excluding a $200 million contribution to our U.S. pension plan, free cash flow would have been up 8.9% year-on-year.

This strong cash flow enabled us to return 318 million in dividends to shareholders during the quarter.

It also bought back 568 million of our own stock, resolving in a net repurchase of $490 million.

Diluted shares outstanding were 768.2 million, down about 2.8% from last year-end and down 50 basis points versus last quarter.

Our total debt to cap ratio was 19.1% at yea-end.

Please turn to chart nine for an update on our global pension situation.

On the asset side, we contributed $654 million to our plans during the year and our pension management team drove another solid year with returns of greater than 10% for the U.S.

However, liabilities increased more than the asset improvement for two primary reasons.

One, interest rates declined by 25 basis points, and two, we updated our mortality assumptions.

Combining these asset and liability changes, our U.S. funded status now stands at 92%, down from 94% in 2004 and, on a global basis, we are funded at a 90% level.

For 2006, we are keeping our return on asset assumption at 8.75.

But as mentioned, we are reducing our discount rate to 550.

We expect our 2006 pension expense to be at $0.26 per share, which is down slightly from 2005.

Please turn to slide ten where I will outline the earnings per share impact from the expensing of stock options.

I thought it would be helpful to give you the impact for both the year and by quarter, as the quarterly amounts vary based upon the grant date.

For comparison purposes we will be restating our earnings per share history.

We estimate 2006 full year stock option expense to be $0.16 per share.

As shown in the table for 2006, we will have some lumpiness due to quarter to quarter, particularly in the second quarter, due to requirement under FAS 123R to immediately expense stock options on grant date for those employees who are considered retirement eligible.

A 3M employee is considered to be retirement eligible upon reaching age 55 with five years of service and accounts for approximately 25 to 30% of our grant award.

Since we grant our employee stock options in the second quarter, immediate expensing of those options to mandatory retirement eligible employees result in higher stock option expense in the second quarter.

For restatement purposes, the [INAUDIBLE] do not allow restatement for the retirement eligible impact.

Please adjust your estimates accordingly.

Before I turn the call over to George, I would like to summarize our outstanding performance this quarter.

We delivered solid local currency growth at 7.3%, including 2.1% from CUNO, along with EPS growth of 14.3%, excluding the impact of implementing FIN 47.

These quarterly results were driven by broad contributions from our diverse portfolio, with particular strength in our electronics and industrial related businesses.

Operating income was up 11% and operating margins improved once again, the 16th consecutive quarter of year-on-year earnings and margin growth for the company.

Our Electro and Communications and Displaying Graphics segments posted local currency growth of almost 11%.

Safety and Security was up almost 10%.

CUNO acquisition integration is on track.

And our business teams were on the wall and they are energized to generate growth in this new exciting segment for 3M.

In summary, it was another quarter which demonstrated the strength of 3M's business model and diverse portfolio, and we are very optimistic about the future.

With that, I will turn the call over to George for some of his thoughts since joining the company late last year.

George?

Thank you very much, Pat, and good morning, everybody.

First I would like to congratulate and thank all 3M employees for their efforts in making this an outstanding quarter and a very strong 2005.

When I spoke to you last in December, I told you that I would be happy to address more substantively my views on 3M at sometime after the first quarter, so I will have only a few comments to make to you this morning.

I have been spending my time this past four or five weeks getting to know the leadership team of 3M and doing in-depth reviews of each business, gaining a more complete understanding of 3M's technology platforms and the markets they participate in.

In a couple of weeks we will be visiting some of the larger international companies. who seem to be very strong and growing quite nicely.

My initial impression is that the technology base at 3M is even better and more rich than I imagined.

And I already imagined a very strong technology base here.

A very pleasant surprise, I found, is that 3M is not just about raw technology.

The process capability that they have and the know how supporting it is well beyond what I imagined.

The stronger focus on doing what's right for the customer is also paying off.

This combination of technology and process technology provides a very powerful and sustainable competitive position.

I think that 3M has hidden a light under a bushel basket with this. 3M's geographical and market diversity is also very strong.

But, also wonderfully simple in concept in that it leverages those same technology capabilities across so many markets and product applications.

And that's tough to beat for anybody.

And this concept is even more powerful when you leverage it across a global stage.

So in conclusion, 3M has a very strong and self-sustaining business model built, not only on individual technologies, but on unique combinations of technology platforms and process capability.

Of course, our task remains very simple and that's to make it grow more substantially and that is what we have been working on as our number one priority.

With that, I will turn the call back over to Pat.

Thanks, George, for your comments.

Please turn to slide 12 where I will provide our guidance for the first quarter as well as the full 2006 calendar year.

For the first quarter of 2006, we expect earnings per share to be in the range of $1.10 to $1.14, including the $0.02 per share impact from stock option expensing, compared to 2005's first quarter, which will be on a restated basis $0.97 which would include $0.06 of stock option expense.

We expect first quarter organic local currency growth of 4 to 7%, with CUNO adding approximately 2.3% of the additional growth.

For the 2006 calendar year, we expect earnings per share to be in the range of 4.45 to 4.60, including an estimated $0.16 per share impact from stock options.

We expect 2006 full year organic local currency growth to be in the same 4 to 7% range, with an additional 1.4% local currency growth from the CUNO acquisition.

In concluding this part of the call, and before we take your questions, I would like to make you aware that we are in the planning stages for an investor event sometime after the first quarter, where you will be able to hear about our plans for 2006 in further detail.

And George and I hope to see many of you at that meeting.

This concludes the formal part of today's call.

Joining George, Mark and me this morning are Matt Ginter, our Director of Financial Planning and Analysis, [Jan Yeomans], our Treasure, and Peggy Smyth, our Chief Accounting Officer.

Be happy to address your questions, so let's begin the Q&A.

[OPERATOR INSTRUCTIONS] Your first question comes from Jack Kelly with Goldman Sachs.

Please go ahead, sir.

Good morning.

Pat, just on health care, you had indicated personal care and pharmaceuticals would probably be a drag for the year.

Given that the core business is growing at 5%, does that suggest, within the context of 4 to 7% for the overall company, that health care implicit in that is somewhere in the 2 to 3% range?

While we are not going to give you a specific number, Jack, but your math isn't probably too far off, with a combination of the core growing at 5.5% and a drag in the other two businesses.

And just secondly in terms of the follow-up.

Given the recent acceleration in LCD film revenues, which you referred to, is 3M now growing in-line with the overall market and I think in terms of 25% revenue growth in terms of where maybe the market is growing at this point?

Well, Jack, we are maintaining a very competitive position in the marketplace.

The LCD TV piece, handhelds were by far the fastest growing pieces of the market this last quarter and we have outstanding performance in those two categories.

We have lost a little business in some of the notebook business and so forth, but we are maintaining our goal there to try to keep up with the overall industry growth.

But, I think as you are well aware, we were starting from a very high starting point, so we do plan to keep growing with the industry.

But as we've told you in the past, the growth of the industry was about 45%.

Our internal plans would say that we probably will grow at something less than that on a going forward basis.

That is a volume number, though?

That's right.

And the pricing you indicated was maybe deteriorated a bit from the 10% you had talked about previously, just by a couple hundred basis points?

We have been -- over time it's hard to describe an average number because it's very product-by-product specific.

But if you went from kind of a trend of 6 to 8, you could say we are probably more now in the 10 to 12 range.

But importantly, what we are trying to do with the customers is to continue to develop new product applications that satisfy their needs.

So with the fast design cycle in this industry, very rarely are you selling the same part number year-over-year.

Okay.

Now just finally, any signs of new competitors, which you have commented on in the past.

No, we have not seen any from a commercial application standpoint.

Okay, thanks.

Your next question comes from David Begleiter with Deutsche Bank.

George, with a little more time at the company, what do you think 3M could do better going forward, specifically on the 3M commercialization of their technology portfolio.

Great question, David.

We've looked at that quite a lot this past few weeks and I think that on the one hand that the beauty of 3M is these technology basis that I talked about.

But I do think we have some ability to speed up the decision-making process, frankly speaking, that could accelerate our growth rates.

So sort of lubricating that part of our business would be the way that I would address that and perhaps simplifying some of the processes that we have to go through our decision making.

Just on the overall portfolio, anything that stands out as being exceptionally strong or exceptionally weak, that needs to be improved?

Well, 3M has a wonderful array of things, as you well know and you are very familiar with it, and there are many strong segments of this business.

I don't know that I have actually come to a conclusion that any one are particularly weak.

I think actually many of these segments, David, are even stronger than I thought they were.

So I see an awful lot of wonderful possibilities, frankly speaking.

And if I sort of thought through the whole process and I said we need six things to drive faster growth, I think we have got five of them in place and the other one is the one that I just talked about.

We just need to be a little faster in our decision making and a little more forceful in our execution and, that apart, I think there is little to be critical of.

And, Pat, one more quick thing, do you expect operating margins in optical film to be flat in '06 versus '05, despite the accelerated price down?

That would be my operating objective for that business.

We will have to make those decisions as we go through the year, though, Dave, depending upon where the growth rate of the industry is and what our OEM customers demand.

So we'd have to continue to play a very high value-add piece for them.

But trying to maintain margins in that business is not a bad objective.

Thank you very much.

See you, Dave.

Your next question comes from John Inch with Merrill Lynch.

Sir, your line is open.

Hi, good morning, everyone.

Good morning, John.

George, the guidance, does it include extra funding for growth based on your orientation toward growth?

Yes.

Clearly we won't be specific on how much we've thought that through, but we have funds available to simulate more growth, yes.

Can you give us a sense, maybe just directionally, of how much and perhaps where within the company you're channelling this?

I don't want to be specific on the exact numbers, John, but clearly there are a number of different marketplaces that are accelerating, some geographic as well as technology markets.

So we are going to have a strong focus on continued growth outside the United States.

Not just in Asia/Pacific, in other places as well.

So that will be a focus geographically.

But in the markets like electronics, obviously the displaying graphics market has gone very, very well.

And we seem to be gaining some good momentum in the Industrial segments.

So I don't think we are going to leave a lot out, though, obviously, we are going to be prioritizing where we put investment dollars to make sure that we get maximum bang for the buck.

International, Electronics, Industrial will be strong focuses for us, but not exclusively leaving other things out.

I understand.

The top-line of local currency, 4 to 7, is below the 5 to 8 target, again, under prior management.

How should we interpret this 4 to 7 versus the prior 5 to 8?

Is this an actual lowering of secular growth or is this just a dynamic driven by Health Care?

I don't think you should read too much in that at all.

I think that's minor edges here and there and, frankly speaking, our ability to -- just as indicated by the range, frankly speaking, indicates our ability to forecast those things accurately as is very, very difficult.

All I can just reassure you is we will be putting a lot of gas in the tank here.

Our foot will be all the way down on the accelerator.

We won't miss one iota of growth that we can get.

So, interpret that we are going to do the best that we possibly can to keep that number as high as it can be.

And then just finally, Pat, was there some sort of a disruption toward the end of December?

Why were the U.S. volumes actually -- why were they actually weaker?

Was there some effort to cut price or did you see any kind of business disruption in the states toward the end of December?

No, we didn't see any kind of business disruption at all at the end of the quarter.

We haven't seen it thus far early into the new year, either.

There really wasn't any kind of disruption.

As a matter of fact, from a more of a manufacturing standpoint, we probably ran more in December than we had in the prior year.

So the down 1.4, how do you characterize that?

I kind of view that as being a little bit of a lumpiness in the results.

If you look at for the whole year, we had our best U.S. local currency growth that we have had in the last four years.

I see it as being unusual.

We had unusual results in Consumer, as I mentioned.

Health Care was a drag on us in the quarter.

But I don't see this as being -- I see this purely being temporary.

So ex-consumer Health Care, there wasn't really a deviation in U.S. trend.

Is that what you -- ?

It was not at all off of what our expositions for the U.S. performance was.

Okay, great.

Thank you both.

Your next question comes from Tony Boase with AG Edwards.

Thanks very much.

I got on the call late, so I apologize if this wasn't addressed.

How are you going to restimulate growth at your personal care in pharmaceutical business?

How are we going to stimulate growth?

On the personal care, the solution there is going to have to be some new product solutions for our customers.

That's the focus.

We are working with the large customers as we speak, proposing some, we think, some very unique solutions that will help them offer even better products.

So that's going to be a product solution basis.

Pharmaceuticals, let's kind of back up a little bit.

We do have a very, very strong product in Aldara.

We do have a few legacy pharmaceutical products that, I mentioned one in the woman's health area, which unfortunately will face some generic competition going into 2006.

And that will be a drag on us going into 2006.

So that portfolio will have a few products in it that will continue to face some weakening in '06.

And foreign exchange, what's your expectation for foreign exchange impact in 2006?

I wish I had a better crystal ball on that one, to be honest with you, Tony.

I have a tendency -- I have been in the industry for about 30 years and I have stopped trying to forecast where foreign exchange is going to go.

Actually tail end of last year that we saw the top-line -- of course translation rates don't go negative on us.

Some of those have started rebound here already in January.

So I don't know where those are going.

We have got a very global business.

We manage it on a global basis.

And exchange is going to be what exchange is.

We have got a hedging program in place that helps to buffer the impact for a given period of time for a year or so, just to try to avoid extreme volatility.

But that's not something we can -- we aren't out trying to guess which way it is going to go and manage it accordingly.

Thanks a lot.

Thanks for the comments.

Thanks, Tony.

Your next question comes from Don MacDougall with Banc of America Securities.

Good morning, everyone.

Good morning.

Don.

Question on the Safety segment.

You had mentioned strong respirator sales, Pat.

I assume that there is some bird flu impact here.

Just curious if you can maybe give us a sense for what that change in demand has been and are we looking at respirator demand back at the SARS level that we saw a few years back?

Don, it's kind of a very unique business because every year there is something that goes on. some sort of an X-factor, be it SARS, be it avian flu or whatever.

We don't really -- I don't have a specific number as to is there a avian flu impact.

All we know is that every year our growth rate continues to grow for that business.

That's what we are anticipating into the future.

So it's just kind of the nature of being in that business.

And we just want to make sure we are going to have enough capacity to keep up with whatever materializes down the road.

And these things,Don, they happened, as Pat said, sort of circumstantially and they are sort of not here today and in full swing tomorrow.

There are plays on inventory you have to have.

Inventory has got to be in the right place.

So it's an interesting business, an interesting dynamic where you are trying to make sure that you are well positioned for the inevitable things in life that seem to go wrong these days.

Okay.

I guess we will leave it at that.

A next question would be on the pricing.

You had mentioned that you did see a fair amount of pricing pressure in the film business.

But you had also said that you haven't really seen any new competitive products.

If so, why is the price coming down and remaining under pressure?

Don, it's kind of the nature of being in that industry.

It's very clear that the OEMs have to drive down price in the end market.

When I say we haven't seen competitors, we also have to make sure that we remain competitive with the flat panel makers, as well as the OEMs, so we don't allow competitors, necessarily, to trench in our position.

It's a very delicate balance that you have to strike between making sure that our customers are successful at the same time that we enjoy the kind of results that we need as well.

So it's kind of the industry that you basically have to -- you can't take the stance that I'm going to hold price up, therefore you basically give either people options to kind of come in and it is such a good business for us that the last thing we want to do is throw away the volume as well as the overall profitability of that industry.

It's something that you have to manage with customers on a one-on-one basis.

It's a classic price volume elasticity issue and there is massive volume available if the price is right.

And then in terms of the competition, the best way to avoid that issue is to continue to invent and cannibalize your own product by replacing it with better ideas and most cost effective solutions to help the customer that we serve be successful.

Understood.

But the question, I guess, that I have is are they -- you had factored price decreases into your plan and that's been the way that business has been running.

Were those price decreases in-line with what you were expected?

Less or more?

I'd say it's not too dissimilar to what our history has been in these type of industries.

The company has had a lot of history working through a number of industries have had very large volume gains with them.

So this is not at all unusual for us.

And one final one, Pat.

Just maybe a lesson on options expensing.

Why is the expense only $0.02 in the first quarter and $0.16 for the full year?

When I look at last year, meaning '05, you had more options expense in the first quarter.

Well, it's going to be a little bit unique company by company, where you see this.

We went from a one year vesting to a three year vesting program in May of '05.

So that's why you have such a big number in the first quarter of '05 is because of, effectively, a one year vesting for that prior grant.

You got that?

Yes.

Your next question comes from Mike Judd with Greenwich Consultant.

Thanks for taking my question.

Your gross margins have, over the last couple of quarters, have been around 51% or so, yet pricing has been fairly flat.

Can you just talk about some of the things that you had been doing to compensate for higher raw material prices and higher energy prices.

I guess I'd start as two-prong.

First and foremost is we have to continue to drive productivity in everything we do.

The foundation for making sure that our margins can stay healthy.

But the other side of it is we have to continue to invent new products for the marketplace as well.

That also enables us to keep our margins up.

So it's really both sides.

It's new product introductions as well as focusing on productivity.

Both of those allow us to keep our gross margins up.

Okay.

And just secondly on the growth side again.

George, you have had really not much time here to really kind of look at things, but what can we expect?

Should we expect to see some acquisitions this year to help bolster growth?

What should we be looking for other than just organic growth?

I think inevitably we will do some acquisitions, that's been a feature of 3M for many years and I don't expect that will change.

And by the way, they can be very helpful in stimulating organic growth as they provide access to new markets, occasionally provide a complementary technology that you want build to offer a solution to a customer.

The acquisitions can be very, very helpful.

Given the capital structure at 3M, with very low net debt-to-total capital, do you feel like this gives you room to do some things which are more than just bolt on?

If you just look at it as a pure mathematical exercise, without saying that we are going to do any one thing or another, it's absolutely clear with the deck capacity that 3M has, lots of different choices are available to us.

So don't take that as an indication that we plan to do either one thing or the other.

We are looking at all of the strategic options that we have, organic growth, acquisitions, obviously trying to find the best segments to invest in.

And to go off and capitalize on some adjacent markets where we have great capabilities that we haven't necessarily applied in those markets before.

All of those things are going to be used.

So what you ought to look for is as we gather momentum, as we sort of get our attraction sorted out here, you will see movement on a broad front in all of the categories that you would expect.

Thank you very much.

Thank you very much.

Your next question comes from Mark Gulley with Soleil Securities.

Good morning, guys.

I want to ask a question on the optical films business.

No secret that you kind of hit a bump in the road on the LCD monitor side a couple years ago when they de-contented films out of monitors.

Can the same thing happened in TVs as well or are films more necessary there?

I guess, Mark, based upon our understanding of design and technology today is that we are even more critical to the performance of an LCD TV than a monitor.

From that standpoint, we continue to work with the LCD manufacturers, TV manufacturers to make sure that they have the best product offering out there and thus far film is a very key component of that.

And as a follow-up, if I read the earnings guidance correctly, and correct me if I'm wrong here, it looks like you are looking for much better earnings growth in the first quarter than the full year.

Are you just being naturally conservative or is there something I'm missing, perhaps, there?

No, it's not and I guess, depending upon how you see it, if you back out stock options all together, I think the numbers are relatively close for the quarter and the year.

Part of the nuance you get is because of the restatement of stock options in the first quarter, there is actually a bigger year-over-year benefit because of the $0.06 we've gotten last year.

But if I look at operationally, our expectations are pretty close on the first quarter and for the whole year.

Okay, got it.

Thank you.

Your next question comes from Dmitry Silversteyn with Longbow Research.

Good morning, thanks for take my call.

There was a question brought up about acquisitions as being a part of your structure going forward.

Can we look at divestitures as also a way to unlock shareholder value, particularly in some the businesses that perhaps have more value to somebody else than to 3M, given the consolidation in the pharmaceutical industry.

Dmitry, that has always been and will always be an option.

Both acquisitions and divestitures are always on the table.

Okay.

And to follow-up on the pharmaceutical part of the business, you talked about the launch of Aldara in '97.

That came off of the immune response modifier which was supposed to be a platform technology to generate additional drugs for submittal to the FDA.

We haven't seen anything in almost ten years to follow Aldara other than increased indications for Aldara itself.

Given that you get more and more products coming off patent, is there a urgency to get new products into the FDA approval by-plan?

Can you update us if any products are getting close?

No, we don't have any comments to make on anything that is in the pipeline at this point.

You are well aware it's a long, lengthy process.

So nothing new to report there.

Then the final question on the use of cash.

You can be debt free, if you really to be, in a couple of quarters.

The stock hasn't done particularly well in 2005.

It sounds like you have a high degree of confidence that you can generate growth in both the top-line and EPS growth that is [INAUDIBLE] current expectations.

Is there a plan on putting your cash work to work and putting your balance sheet to work in terms of a greater repurchase program than just enough to offset dilution?

We have not begin with the board, yet, a plan for 2006.

If we go back to 2005, we indicated that we had a record buyback program, dividends were up, we returned $3.6 billion to shareholders.

I think that indicates kind of our thought process.

We need to sit down and review that with the board,,again.

And we will let you know as soon as we've got that lined up.

Okay, thank you very much.

Your next question comes from Bob Cornell with Lehman Brothers.

Thanks.

George, I got a couple questions for you.

When you came on over to 3M and those issues around dealing with the kind of scope and scale that 3M has.

You sound pretty calm and cool and collected this morning.

What's your comment in that regard about 3M as a huge global entity, getting your hand around it.

Well, it is very interesting to have read those remarks earlier and I don't see really 3M as being that much tougher than things I have done formerly.

I've worked in very large organizations before and dealt with this sort of breadth and complexity.

It has never been an issue for me in the past and I don't see it's an issue today.

I think -- we are obviously going to be very careful that we don't commit ourselves before we are absolutely certain what the plans are and should be.

I can assure you that we are digesting the size and scope of 3M and I think that the opportunity -- I genuinely, most sincerely think the opportunities here at 3M are absolutely colossal.

And my brand of growth oriented leadership will, when mixed with the great people here and the great technologies, is really going to do great things for this company.

You just have got to give us a little time but I don't see any big challenge there, frankly speaking.

Sort of a related question.

The guidance you guys put out today is a little below what we might have expected in terms of for the prior 3M earnings growth numbers.

And one thing that's been happening over the last couple years is R&D as percent of sales has been coming down that has helped the earnings growth.

Do you see the R&D as a percent of sales going back up from current levels as a part of minding the global opportunity at 3M and where do you think R&D should be as a percent of sales?

We will be investing not just in R&D.

It's clearly the product is the program, shall we say.

But we also -- we perhaps don't spend as much money as we should in the customer facing issues.

In some cases in marketing, but in other cases in service support.

You are going to see some change in the investment pattern that we make there.

A lot of stuff already that we got our ideas on is already in the cupboard, but which hasn't been launched.

I think it's -- and you hit on the right point here, Bob, that we have to make some investments if we want to drive growth.

So I think you can reasonably expect to see an altering of the profile of R&D and in those other I think I just mentioned.

So stay tuned.

I guess the final question is that some investors have worried that with the new CEO coming in to a complex something like this, there would be some big bath phenomenon of some sort.

We didn't get that today.

This is -- how would you react to the investment community in the context of some major big bath issue in terms of writing stuff off or whatever?

Well, I think 3M has been such a superbly managed company over the years, it is, by its nature and you know it well, it is by its nature a very conservative company.

And so I don't think that the place has too many surprises in that context.

We used to call it in some previous things the new President's dump.

But that's not what you see at 3M.

It doesn't mean that there aren't things that we can do better and it doesn't mean that has business has evolved and they, some said, that you shouldn't do some things.

I'm glad that you noticed that we didn't do anything radical this morning.

We are paying attention.

Good luck, thanks.

Thanks, bob.

Your next question comes from Robert Ottenstein with Morgan Stanley.

Hi, guys.

As you look out over to 2006, forgetting the macro-economic environment, what are you most concerned about?

I guess from my standpoint, Robert, this is Pat, I will tell you what I'm not too concerned about is I think we've got the capital structure is in very good shape for the company.

Productivity programs are very well entrenched.

I can't manage foreign exchange from where that's going from an external perspective.

So the real issue is growth.

Our big issue is going to be how do we get the top-line of the business going a little faster.

That is what our primary focus is going to be on is how do we get the top-line moving a little faster.

In terms of delivering the numbers, you would have a very high degree of confidence in your guidance?

I feel pretty comfortable with it, Robert.

Stuff always happens, but we've had a track record of delivering what we tell you we're going to do.

So from that standpoint how we get there, as the year unfolds we will figure out the pieces.

But I feel we have got a very solid plan in place to give you what we -- what guidance we have given you there.

I think part of what George and I have to step back and look at is how much money do we help put back into stimulating a little more growth.

I think, Robert, with -- and I know that you know this well, you are very experienced in these matters.

On the one hand 3M's breadth and diversity and particularly its geographical diversity, I know that Pat has pressed this point many times before, it's a wonderful insurance that you are not damaged or impacted by, too severely at least, by cold winds of change or circumstance in a particular market or particular geography.

That's its great attribute.

On the other hand, it also means that you got more pieces to play and it takes more effort, obviously, at some level to drive growth.

So I think -- it's just the breadth of 3M, which is such a positive attribute that prevents many of the more unfortunate things that can happen to some companies happening to 3M.

Can you talk a little about the CapEx outlook for next year?

Yes, I can give you an early indication, Robert, at least where my head is in gain.

Of course, George ingrained more and more every day here.

We spent about 950 the past two years.

To be fair, we have a number of supply chains who are starting to reach capacity limits and at some point is starting to hurt us from a customer service perspective.

We will be investing more capital during 2006 to alleviate some of those bottlenecks as well as to make sure that our optical film business is ready to participate in the growth of that business.

So I'm thinking right now that our capital will probably go up to about $1.1 billion next year based upon the plans that we are currently running to for the year.

We will know better as we go through the year and see what the other spending levels are in the first part of the year.

But we got a number of good businesses who will need some additional capacity.

We talked about Safety, Security a little bit earlier on personal protection, respirator systems and so forth, we are tight on capacity there.

We are going to have to put some more capacity in there.

Medical, we have got some more capacity to go in.

There are things like roofing granules.

We have got some more capacity put in for roofing granules, which is a great business, especially in the southeast right now, with the rebuilding effort that's going on.

So we have a number of pockets where -- but importantly it's all headed towards good growth and good return projects.

And add to that 1.1, how much would be optical?

We generally don't give that out, but I would -- it would be fair to say that I love the place that we are in relative to our capital tradeoff versus earnings potential versus the rest of that industry.

Thank you very much, guys.

Thank you, Robert.

Your next question comes from Jeff Cianci with UBS.

George, your predecessor put a lot of effort into Six Sigma.

I know you have experience there and success.

First your assessment of where are we on the cost side of the equation in terms of are we in the third inning here?

How much is left in terms of projects not yet completed?

And second, can it be a driver of growth?

Jim used to talk about how eventually you could move these projects into driving the top-line.

What's your near-term assessment on that?

First of all, I think the company is to be congratulated for the wonderful work it has done on things like Six Sigma.

It's being responsible, not wholly responsible, but partly responsible for the margin improvement that you have seen over the past few years.

And certainly my assessment is, and I know that Pat supports it, is there is a lot more juice in this lemon yet.

And actually an area where we are feeling some senses in the early days of our development is really leveraging our procurement efforts.

So I think that there is a lot more yet left in this, Jeff.

Whether I would argue that Six Sigma itself can drive growth, what can happen is you get your productivity up so hight that your cost position becomes very attractive and then you choose to use some of that cost position as a means of driving volume.

So I think that theoretically, at least, there is a transition that could come in the future there.

I don't think we are at that stage right now.

So I think there is a lot more to be had from all of those bearish activities that the company started and I am a strong supporter.

I think what we will do is we will step on the gas fairly heavily on lead manufacturing now, in addition to Six Sigma.

And we will certainly step on the gas on global procurement and on enabling, as Jim would say, the front end of our business, the customer facing parts of our business.

They will be the places where we push more aggressively, perhaps, than we have in the past.

Okay, great.

Thanks.

Your next question comes from Jeffrey Sprague with Citigroup.

Thank you, good morning.

Just maybe a couple more questions on the film business and maybe expanding on the capacity expansion.

Certainly there has been a lot of capacity expansion announcements from your customers, also, and I would imagine, but correct me if I'm wrong, that you wouldn't necessarily intend to expand and lock step with them.

Can you just kind of talk about balancing your capital spending and your vision of where the growth is versus maybe the aspirations of your customers who are pushing for volumes.

I think, Jeff, you may be implying a little bit, I think, that is there too much capacity in the ground.

We try to manage, from our standpoint, looking at each one of the customers, their schedules, their programs, what kind of commitments they've got and then we will respond with our capacity.

We have a tendency to run relatively tight from a capacity standpoint.

Our lead time in many cases is nowheres near their lead times relative to putting capital in the ground.

So we are a little bit further down the stream a little bit that we can kind of wait a little bit and make sure the market does develop before we have to make some major commitments.

Again, major commitments for us is nothing near like the kind of commitments that they make.

You are talking about a major commitment for us versus what they did in say a fab facility is probably about 5% of the capital that they will put in.

So the risk profile is quite a bit different there.

But we can respond a little bit later.

And as we continue to introduce new products and we get those accepted with the customer, we then have a better read as to where our volume is going to go as well.

Our guys are very well situated with all of the OEMs.

They are on top of them all the time.

We are just not reading some forecast that says just because somebody says it is going to go 45%, we are just going to go invest on that basis.

We are a little bit like from Missouri, show me and we will respond.

I was wondering if you could elaborate a little bit on, as you see it, the state of play in inventories and distribution and such in the business.

My question is really kind of revolves around the issue of comparisons.

Clearly your Q4 growth in the business looks the best we have seen this year, but the comps were pretty easy.

If I add the quarters of '04 and '05 and sum them, the sum of the growth of the two quarters that end here is actually the slowest of the year, then you could go back another year and say well that comp was tough.

There is a lot of stuff moving around.

As you ended the season here, what do you think about inventories and is there anything to think about in the first half of the year as we come off season a little bit?

Well, I guess you summarized that pretty fairly.

Let's face it, being in this business is going to have some volatility.

You have got some natural seasonality.

You have also got the issue of -- you got a significant technological transformation going on in as too -- and those very rarely go that smoothly.

There us going to be peaks and valleys associated with it.

So, we obviously keep a very close look on that.

Thus far our feedback on inventories are inventories have not been an issue.

So it looks like, at least thus far, is going into the year we should have some good momentum going into the first half of '06 based upon our intelligence right now.

But it's easy for a customer to call up a week from now and say, halt, I don't need products.

But this point in time our visibility would say that the growth is still materializing as we had thought it would.

Seems to me that the holiday season was very effective.

That, of course, is always the thing you keep your fingers crossed for is don't have a hiccup during the holiday season.

By all accounts the holiday season was good.

Got the Olympics coming up.

That has a tendency to bump some sales as well.

More so outside the U.S. than inside the U.S.

We will keep tracking it, but thus far it looks good.

And it's a good sense of momentum in some of the businesses that we have.

You saw great numbers in industrial and great numbers in the electronics area.

So it doesn't seem that we have an issue there.

And just one final one for you, George, is as you think about your options maybe in three big buckets and it's acquisitions, internal growth or return some of this cash to shareholders and it's probably not absolutely one over the others, it's some combination.

But specifically when you think about acquisitions and the opportunities and assessing the abilities of the company, what is your initial view of the people, the process, the hurdles, the track record of 3M around acquisitions historically?

Well, acquisitions are -- can be challenging things to companies.

The issue of making an acquisition successful or not are really tied to two fundamental things.

One is to make sure it's absolutely key to the strategy.

Don't go buying things just because they are available, clearly.

And while that may sound very obvious, I have seen companies make mistakes on that kind of stuff before.

The real value is gained in the integration and the drive for synergies.

So part of the plan for us is going to be absolutely sure that we have a robust plan, integration plans and a, shall we call it almost rabid attention to driving the synergy list because that's what creates value for the shareholders.

So I have seen some companies do that kind of stuff very, very well, and there are things that we can do, perhaps, to improve that in 3M.

And in terms of the three buckets you speak about, growth in terms of pure value creation for shareholders has got to be the one that's first off the bat.

So that has got to be our first activity.

And these are all just essentially choices in the return on investment spectrum that we will be making, but from our perspective, organic growth is the clear number one thing that Pat and I want to pursue.

Thank you very much.

Thank you very much.