3M (MMM) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded Friday, October 20, 2006.

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

Good morning.

I'm Matt Ginter, Vice President of Financial Planning and Analysis and Investor Relations for 3M.

I'd like to welcome all investors to our third quarter 2006 business review.

Allow me to make a few brief announcements before we begin.

Today's discussion will follow a series of PowerPoint slides which are currently available on our Investor Relations website at 3M.com.

These slides will remain on our website, along with an audio replay of today's call, for an extended period of time.

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

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

Item 1A of our most recent form 10-Q lists some of the most important risk factors that could cause actual results to differ from our predictions.

Both Pat Campbell, our CFO, and George Buckley, our Chairman, President, and CEO, will make some formal comments on our results in our forward outlook today, and then we will open it up for Q&A.

So now please go to slide number 2, and I would like to turn the program over to Pat Campbell.

Thanks, Matt.

And good morning, everyone.

It's a pleasure to be with you.

The third quarter was a good one for 3M.

And there are a number of items I would like to highlight about our performance.

First, we continue to make good progress towards being a more consistent and faster growth company, while maintaining our superior margins and return on capital.

This was the third consecutive quarter of achieving record revenues and the fifth consecutive quarter in which all sections of our businesses posted positive local currency sales growth.

Sales increased almost 9% year-over-year reaching an all time quarterly high of $5.9 billion.

Organic local currency growth in the quarter was 5.6% and acquisitions added an additional 1.7% to growth.

We have accelerated the pace of acquisitions and year to date have announced 16 transactions that will add approximately 350 to 400 million of additional sales in their first full year with 3M.

As we anticipated last quarter we saw a nice sales rebound in our optical film business in Q3 driven largely by accelerating consumer demand for LCD televisions.

Optical films posted record sales in the quarter and volume growth was over 20% year on year.

Reported operating income was 1.3 billion in the third quarter and margins were nearly 23%.

Adjusting for differentials in year-over-year stock option expense and for pharmaceutical related transition costs operating margins were nearly 24%, matching last year.

Earnings per share, again on reported basis increased 9.3% to $1.18 which includes approximately $0.02 per share penalty year on year related to stock option expensing.

EPS would have increased at a double-digit rate adjusted for special items and stock option expensing.

Free cash throw was 787 million, an increase of 11.6% over the third quarter of 2005.

During the quarter, we repurchased a record 1.2 billion of our shares, taking advantage of a significant under valuation of our stock price and our Board of Directors authorized an additional 1 billion in share repurchases raising the total authorization to $3 billion covering the period from February 2006 to February 2007.

Please turn to slide number 3 for a recap of our sales performance.

As I mentioned, worldwide sales increased 8.8% versus last year's third quarter.

Volumes increased 8.2% with organic volumes up 6.5% and acquisitions adding 1.7% to growth.

Selling prices declined 90 basis points while translation added 1.5% to third quarter sales.

In the U.S., sales improved 6.2% versus last year's third quarter.

Organic local currency growth in the quarter was 4.4% with volumes up 3.4% and selling prices adding a point.

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

Acquisitions added 1.8% to U.S. growth in the third quarter.

Sales in our international operations were up 10.6% in U.S. dollar terms.

Organic volumes increased 8.6% with particular strength in China and Korea.

In addition, Europe had an outstanding quarter with organic volumes up 5.3%, which is about where they stand on a year-to-date basis.

We are very encouraged by the performance of our European business teams.

As expected, international selling prices decreased 2.2%.

Acquisitions added 1.7% of additional growth outside the U.S. and foreign currency translation increased international sales by 2.5 points.

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

Note that we elected to restate prior periods for the expensing of stock options.

This chart also excludes special items in this year's third quarter.

As I previously mentioned, sales were up 8.8% versus the third quarter of 2005.

Operating income was 1.4 billion, up about 7% after absorbing a negative 1.5-point impact from year on year differences in stock option expense.

Operating margins were a strong 23.1% in the quarter, which is flat versus last year's third quarter after adjusting for stock options.

Third quarter gross margin was 48.9%, down 2.1% year on year.

Let me break out this reduction into two primary parts.

First, about a quarter of the gross margin change was due to non operational items, namely changes in FX rates and difference in stock option expense.

Second, the remainder of the changes relate to what I will call more operational.

That is, some very specific circumstances in a few of our businesses that we are carefully managing.

Of the operations, more than half is related to our LCD film business which we discussed in last quarter's earnings call.

The LCD TV market is growing by leaps and bounds, which is driving much higher sales for this business, albeit at a lower overall gross margin.

The manufacturing issues we experienced last quarter were largely resolved as the quarter proceeded.

The remaining operational impacts on gross margins relates to a handful of supply chain inefficiencies that we are working through.

Part of this relates to strategic actions we have taken to move production closer to customers and others are capacity related.

These businesses include roofing granules, medical supplies, and respiratory products to name a few.

In dollar terms, SG&A expense was essentially flat year on year, but with increased volumes we ended up at a 20% to sales.

We continue to invest in growth oriented SG&A.

For example, total selling expenses, which include such things as sales reps, advertising and merchandising and marketing costs, increased in line with revenues.

In other SG&A cost categories that are less tied to growth, and are more of an administrative nature, our objective is to drive greater leverage and, in fact, these expenses were down versus last year's third quarter.

R&D expense increased 8.1% year on year or 5.8% to sales.

Third quarter net interest expense was 24 million versus 7 million last year, primarily related to increased debt levels supporting our share repurchase activities which we believe was a good use of cash.

The sequential quarterly P&L comparison is found on slide number 5.

Sales were up 3% versus the second quarter, with the largest increases in consumer and office driven by the because to school shopping season and mass retail, and the do it yourself retail channel, along with display and graphics, as LCD film volumes accelerated in Q3 due to strong consumer demand for LCD TV's.

Operating income increased 10.6% sequentially as a result of sales leverage, good cost discipline, and a 4.4% sequential reduction in stock option expense.

On a sequential basis net income increased 9.4% and earnings per share increased by 11.4%.

Stock option expense was $0.04 per share in the third quarter versus $0.07 per share in the second quarter.

Please turn to slide 6 for a quick review of our year-to-date performance.

In addition to delivering consistent quarterly performance, it is critical that we remain focused on delivering solid performance over the long term to deliver increasing value to our shareholders.

In terms of operational metrics, we are performing at levels very similar to last year.

Which was an outstanding year for the Company.

Year to date, we have been able to leverage the top-line growth of 8.2% ad the earnings per share growth of 9% excluding special items in each year.

On a year to date comparative basis, stock options had a negligible impact.

Operating margins remain at a very healthy 23%.

We have delivered the results with simultaneously accelerating investments to faster grow the business.

Please turn to slide 7 while I recap our third quarter segment results.

Our industrial and transportation business had a very strong quarter with 6.9% top-line local currency growth and a 16.1% profit growth.

Of that revenue growth, acquisitions contributed 2.4% in the quarter, primarily from one month of CUNO sales which we have now anniversaried.

Organic sales growth in the quarter was led by our industrial adhesives and tape business, abrasives business, energy and advanced materials business, as well as our automotive aftermarket business which sells products in the body shops for vehicle repairs.

Growth was muted in the quarter by our business that serves all tiers of the global automotive OEM market.

New car builds continue to remain soft particularly in the U.S.

Geographically speaking, Asia Pacific led the way in industrial and transportation this quarter with double-digit local currency growth.

Operating income in the third quarter was $340 million.

Our healthcare business which supplies a broad portfolio of products and solutions to hospitals, clinics, dentists, orthodontists, generated sales of almost $1 billion in the quarter.

The underlying fundamentals in healthcare remain very strong, driven by aging populations and the continued trend towards western healthcare practices in emerging economies.

We are investing in sales and marketing and R&D while adding products and technologies via acquisitions in our core strength areas such as infection prevention, wound care, dental, and orthodontic products and systems.

Organic local currency growth was 5.1% with acquisitions adding an additional 90 basis points at growth.

Growth was led by medical supplies, dental, and drug delivery businesses.

Many of you know that we are currently seeking strategic alternatives for our pharmaceuticals business, and while I have nothing new to report today, I am hopeful that we'll bring closure to this project soon.

Excluding pharmaceuticals, which is approximately 20% of healthcare revenues, third quarter local currency growth in healthcare was approximately 8%.

Geographically, healthcare's revenue growth was strongest in Europe followed by Asia Pacific and the U.S.

Operational income was up almost 10% in the third quarter including a 1.1% percentage point increase -- 1.1 percentage point negative impact from stock option expensing.

We achieved this growth in income even as we are moving some of our medical business supply chains to locations that will give us much lower costs in the long term.

Let's now move to display and graphics.

Local currency growth was 8.2% in the third quarter, driven largely by optical films.

Third quarter operating income was $300 million, as operating margins returned to 30% plus levels.

Profits improved by $59 million sequentially.

As anticipated, we saw an acceleration in the LCD industry due to strong consumer demand for LCD TV's in advance of the upcoming holiday season.

Our optical films business posted record sales as volumes increased greater than 20% and selling prices declines were in line with our expectations.

This business remains one of 3M's jewels, combining an unmatched intellectual property portfolio with advanced manufacturing process technologies to meet the long-term cost and performance requirements of the fast growth flat panel display market.

Many of you know that there are two other very large market leading businesses within display and graphics.

And both are growing very nicely.

Our commercial graphics division posted double-digit volume growth in the quarter, and sales volumes and traffic safety systems increased at a mid single-digit clip.

In consumer and office, we continue to penetrate our large key accounts, primarily in the U.S., with an array of unique highly functional products featuring customer-inspired designs.

The team here has developed a strong track record of introducing innovative new products by leveraging technology and process capabilities across the Company.

Local currency sales growth in this business was 5.8% in the quarter, led by our construction and home improvement division which serves the large do it yourself retail channel.

We also posted very good sales growth in the mass retail channel in conjunction with the back-to-school season.

Operating income in consumer and office was 181 million, up 6.9%.

Safety, security, and protection services businesses had another outstanding quarter.

Local currency sales increased 17.1% including 6% from acquisitions.

You may have seen that in August we acquired Security Printing and Systems Limited, a leading provider of finished personalized passports and secure cards based in the U.K.

The addition of Security Printing Systems Limited to our line of products for secure documents will allow us to deliver a full range of border and civil security solutions products.

Once again, organic growth in the business was driven by a strong global demand for personal safety products, especially respiratory protection.

We continue to invest in additional respirator capacity to support ongoing growth that we see in this business, including our recent announcement of a new respirator manufacturing facility in Korea which will serve the Asia Pacific region.

We also posted outstanding growth in corrosion protection division, a smaller but growing business supplying coatings for all types of commercial and industrial applications in a variety of industries.

Geographically, local currency growth was positive across all regions of the world led by Europe and the U.S.

Operating income was 148 million in the third quarter, up about 8% versus last year, including a 1.1-point negative impact from stock options.

Profits grew nicely in most parts of the business with the exception of roofing granules, which was impacted by higher copper costs and greater freight equalization expense.

In electro, communications, organic local currency growth was 1.4% versus last year and profits were up just slightly at 124 million, or almost 20% to sales.

Year on year differences in stock option expense hurt profit growth by 1.3%.

Operating margins continue to be impacted by rising raw material costs, specifically copper, in our electro and communications market businesses.

We generated good top-line growth in our electrical markets division which sells a number of insulating, testing, and connecting products and solutions to both power utilities and manufacturing OEMs.

We continue to see good growth from our electronic market business driven by double-digit growth in our semiconductor and assemblies businesses.

Partially offsetting this was some sales softness in our U.S. communication market business due to the higher copper costs.

Acquisitions added 2 points of growth as we have acquired a few small but fast growing products and technologies to compliment our flexible circuit and static protection businesses.

Please turn to slide number 8 where I will review a few balance sheet and cash flow metrics.

Networking capital turns were 5.1, down slightly versus the second quarter and down 0.4 turns versus the third quarter of 2005.

As is typically the case, receivable turns were down slightly in September versus June, due in large part due to traditionally strong September month end sales that ultimately are collected in the fourth quarter.

Inventory turns on the other hand improved slightly versus June for our lower than a year ago levels.

As mentioned on previous calls, we have built inventory in 2006 in many businesses in order to improve service levels.

And, in fact, many of our businesses service metrics have gotten much better.

On the whole, however, we still have significant opportunities in this area, and, of course, our Lean manufacturing initiative is aimed squarely at this.

Capital expenditures totaled 312 million, an increase of 104 million year on year and 51 million sequentially.

To date we have spent 763 million of our expected 1.1 billion in CapEx for 2006 as we continue to invest in a number of growing businesses.

Free cash flow in the quarter was a solid 787 million up 11%.

Dividend payments to our shareholders were 342 million up over 6% versus the third quarter of last year.

And we aggressively bought back stock during the quarter with gross share repurchase of $1.2 billion, almost double the amount purchased in last year's third quarter.

As I previously mentioned, during Q3 our Board of Directors authorized an additional 1 billion in share repurchases raising the total authorization to $3 billion for the period from February 2006 to February 2007.

As of the end of the third quarter, we have almost $1 billion remaining within the authorization.

This concludes our discussion on the quarter now I would like to turn the call over to George who will address our expectations going forward.

Please turn to slide number 9.

George.

Thank you very much, Pat.

Good morning, everybody.

Before I address our forward outlook, let me make a few brief comments about our third quarter results.

We made significant progress on many fronts during the quarter.

Our efforts to accelerate the sales growth of the Company continued to progress as we delivered our third consecutive record quarterly sells and added some exciting new products and technologies to the Company through acquisitions.

LCD films we saw continued manufacturing process improvements in this business as the quarter progressed and the new production line is now behaving in line with our expectations.

We continue to invest in additional capacity in many new core growth businesses.

Finally, during the quarter, we used our strong balance sheet and cash flow position to opportunistically buy back 1.2 billion of our own stock, in addition to distributing over 300 million of dividends to our shareholders.

All in all this was a good quarter for 3M.

Looking forward to the fourth quarter we see nothing at the moment that would steer our ship off course and economic conditions appear to resemble those in recent quarters.

For our business we expect organic local currency sales growth in the range of 4 to 8% with acquisitions adding an additional 1.5% or so of growth.

Fourth quarter earnings per share are expected to be in the range of $0.97 to $1.04, including the effect of an estimated $0.12 to $0.13 per share of one-time acquisition costs related to the purchase of Brontes Technologies Inc., an acquisition which we have announced on Monday of this week.

Also included in our fourth quarter earnings is $0.04 per share cost from stock option expensing.

As in the past two quarters, we'll likely incur some additional expenses associated with our efforts to seek strategic options for our pharmaceutical business, and if we consummate a transaction in the fourth quarter we will incur some restructuring related costs associated with selling that business.

None of those charges are included in our fourth quarter guidance.

That concludes our formal comments.

We'd now be happy to take any questions.

Thanks a lot, everybody.

OPERATOR INSTRUCTIONS] Your first question is from the line of Bob Cornell with Lehman Brothers.

Please proceed with your question.

Great looking quarter I must say.

On the film business, the -- how did that business track through the quarter?

I think when we talked in July, there was not a sign that the business was accelerating.

Could you give us an idea how it ramped through the quarter and how it looks like it's going to track in the fourth quarter?

I'm sorry, Bob, I missed the very first.

You're talking optical?

First first thing I said was a good quarter, Pat.

I heard that.

Thank you.

I guess I was thinking about that piece of it.

I understand.

I want to know how the optical film business ramped through the quarter--. [Multiple speakers] not really reflecting the seasonal demand, so how did that ramp and what's the exit rate in the quarter?

Well, as we talked about in last quarter, we thought it would take, a -- the early part of the third quarter to kind of get through some of the inventory correction, and it played out really the way we had anticipated, that as the quarter progressed, you've got the back half of the -- back half of the quarter we saw very strong -- very strong demand in that business, so it played out the way we thought it would, so, soft early, early in the quarter, and accelerated as the quarter went on.

Now seasonally would you expect that strength to continue into the fourth quarter?

Yes, we would, and as TV has become a bigger and bigger percent of the mix we'd expect that the back half of the year would become a bigger piece of that business than it has historically been, and, of course, what we'll have to keep our close eyes on is how well the holiday season actually sells through.

Now, you mentioned the new line was up and running and meeting expectations, but as I recall in the last call the idea was that when you got that line running both with regard to speed and size, that the margins on the LCD film would go up and approach the group average.

Do I remember that correctly?

And if not, what's the problem?

Well, no, -- well, first of all, D&G did return, okay, to a very healthy margin rate.

Basically what we're saying on the manufacturing side is we're back to the rate that we thought that the improvements in that line would have.

It still has some further upside to it over time as we continue to improve its capability.

So there still is more potential out of the equipment but we've got it back to the ramp rate that we had hoped it would be on at this point in time.

Okay.

I understand.

One final question from me.

You mentioned steady as you go on the economic front.

What were some of the exit rates in the quarter in the consumer businesses here in the U.S.?

Are you seeing any of the softening that some of the other companies are, to talk about?

We didn't see really any softening on the consumer side.

That's a very, very good business that Moe has, and he's continuing to grow it with a lot of the big retailers.

Now, of course, the thing you always have to watch is back to school seemed to go fine for us.

Now the next big season will be the holiday season, but right now we don't see any warnings signs, and my own personal view is hope with -- to some degree, with the reduced gas prices here, maybe that's helped out the consumer a little bit, but thus far we're not seeing anything.

Notice also, Bob that we saw pretty good growth in the CHIM business, that's the consumer home improvement business.

Thanks, I'll pass the baton.

[OPERATOR INSTRUCTIONS] Next, David Begleiter with Deutsche Bank.

Good morning.

Very nice quarter.

George and Pat, in optical and display do we get back to prior margins in '05 and '04 when the new line comes up to full, or expected rates, and if not, what's the expectation on a margin erosion optical over the next couple of years?

Thank you.

Dave, let me -- I'll try to address the first part of your question on historical margins.

I think it would be fair to say that as business expands in these fast-growth electronics markets what you end up with is far more volume, far more dollars of profitability, but usually at lower margins over time.

So I don't necessarily see it -- see us getting necessarily back to the margin rates that we had in the '03, '04, and even some of the '05 time frame, but there's very sizable growth opportunities still left in that business.

So you've got to go after the growth and we'll continue to work at the margin side of it through manufacturing improvements and cost controls, but now it's a matter of trying to capture as much of that volume increase as we can.

We have a pipeline of products that continually reduce cost of the products, partly through manufacturing and partly through design, and even in the current lineup of manufacturing, we have increased line rates and other things that we're working on that will drive overall manufacturing costs down.

Very good.

Very strong quarter in industrial.

George and Pat, how sensitive is your business to both U.S. industrial production as well as global i.e. IP?

Well, I would say we're very linked to the global.

I don't pay as much attention to -- I'll call it the U.S. by itself.

That truly is a global business.

Manufacturing is moving out of -- more the western world into the more developing parts of the world.

And we've got a great -- we've got a great franchise here to capture that business movement.

And there's just such -- so much potential, okay, in parts of the world relative to growth that we're going to chase that around.

That obviously will be aligned to overall industrial growth, but we look at it more on a global basis.

How much of that business is overseas right now, Pat?

I would say they pretty well mirror the Company.

I'd say they're about 60% outside the U.S., if I recall the numbers.

It's about -- it it's in that ballpark.

Thank you very much.

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

Please proceed with your question.

A question about copper.

Approximately how much copper do you purchase per year?

It's not -- Mike, offhand, I don't have the exact copper number.

It is limited to a handful of businesses we're in.

It's not a big commodity for the Company as whole but it does impact a couple of specific businesses.

As I mentioned, our communications market.

It does impact that.

It also impacts our roofing granule business that includes copper in some of these shingles that some of the OEMs produce.

So it's kind of -- it's a little bit more of a narrow issue for us in a handful of businesses.

Do you hedge or not?

On copper?

I wish I had, okay, back when it was a buck.

All right?

Sure.

So the answer is, it's a little bit too late right now, but it is something that we have to take a look at over time, and there's two ways of hedging.

There's hedging, obviously we do as a manufacturer, there of course are some things also you want to do within contracts with customers to help protect against the volatility in copper.

Unfortunately, I'm not so sure any of us had the right crystal ball a couple years ago when this thing started to take off.

Secondly, in pharma, I think you described your activities, your strategic alternatives as potentially something might happen soon.

Can you just provide a little bit more color on that?

In other words, do you have a number of interested parties in that business, or is it just one?

What are the issues in terms of completing that particular strategic alternative?

Well, Mike, it obviously is not in our best interest or your best interest to kind of disclose where we are in the precise negotiations.

I think our comments on getting this done soon are reflective of what our intent is.

Just lastly on acquisitions, do you have any kind of plan in terms of a dollar amount that would be sort of max, min, in terms of what you might be looking to spend in '07?

Is there some sort of budget for that, or is it more opportunistic?

I'm sorry, to spend for what, Mike?

Acquisitions?

For growth.

If you step back, of course we do financial planning as to what the capability of the enterprise is, but we don't have a specific number that we have targeted.

In New York I think we presented a model that said 4% to sales is something that we're looking at over time, from a growth rate standpoint in the 2 to 4 range.

But there's not a budget per se.

Thank you.

Your next question comes from Jack Kelly with Goldman Sachs.

Please proceed with your question.

Good morning.

Good morning.

Pat, you had mentioned 20% plus volume gain in LCD film in the quarter and the back half was stronger than the first.

Can we kind of assume from that, that you're currently shipping along with the growth rate of the industry?

In other words, if -- it appeared for awhile from a volume standpoint you were trailing the industry, prior to the June hiccup, but it sounds now like you're more in tune with the markets growing.

Is that kind of your perception?

Jack, that's a fair read based upon the intelligence that we have relative to the shipments of the OEMs, yes.

Okay.

Then secondly, when you talk about gross margins coming down, you had indicated it was because -- I thought you said because you're selling more film, et cetera.

Which struck me as strange because it sounds like the gross margins on film, up, ex the Alabama thing, shouldn't have come down a lot more.

You had mentioned pricing was coming down about the same, which was 12 to 13%, volume is turned.

So are you saying margins are down year over year in film?

Because it sounds like prices are being cut more than one would have thought but you didn't really say that.

Yes, Jack, a lot of this, if you go back to the conversation we had last quarter, where we talked about both pricing and mix of that business, beyond some of the production issues, we did have a change within our margin structure within the film business.

Of course, that continues on here.

It still is very positive.

If you look at it at a company mix level, selling more film is absolutely great for us.

It's just that the margin itself, the absolute margin within the film business has come down and still absolutely fabulous business.

We'll have to keep chasing the manufacturing side of this, get the cost in line to keep the profitability up with what we're going to have to give away from a price -- price down in that market.

Well, that seems to be the contradiction though, it doesn't seem like the price is going down more than it was two quarters ago, or is it?

Well, not more than it is two quarters ago.

Just go back, though, to the last quarter where you looked at -- if you looked at that D&G results where you looked at year on year we had a drop off in the profitability of the D&G business.

Of course, we got some rebound here in the third quarter, some of our manufacturing operations improved, and actually we had probably some mix enhancements in that business.

So we did get some of it back in the third quarter.

But it still is below where we were last year.

Finally, George, just on inventories, you had talked about in prior quarters you need to build inventories to better service customers.

Is that inventory build for that reason over now?

Well, we hope to get the turns headed in the opposite direction now, Jack, we see that as one of our opportunities now going forward.

I think that the longer term issue, Jack, for us is to straighten out our supply chain that will cut out many of the steps that build and in some cases end up with finished goods, inventory, parts in the wrong places.

So I think in the near term you should expect to see stabilization and/or small improvements but longer term accelerating improvements as we get the underlying infrastructure in the right place to make it better.

Thanks.

Thanks, Jack.

[OPERATOR INSTRUCTIONS] Your next question is from the line of John Inch with Merrill Lynch.

Please proceed with your question.

So the Decatur film line, roughly speaking, Pat or George, what yield run rate are we at as you exited the quarter or today?

Well, it was multiples, for competitive reasons, John, we wouldn't want to quote the precise number, but it was multiples of what it was in the second quarter.

I mean, George, you had, I think, if I'm not mistaken, there was sort of an expected kind of range that was always, call it 20 points or so below at the high end from the other film line.

Are you getting close -- I'm making up numbers, let's say 10 to 40.

Are you close to that 40 threshold, or do you think there are still material productivity improvements or improved yields to go on that line?

The answer John to both questions is yes.

We're already in the range that you are speaking of, but because of the other productivity work which is ongoing, for example, we will be doubling the width of the films and increasing line rate so we are going to see I think some helpful improvements both in yield because of the wider films, but on top of that some higher volume going through that plant so we'll got productivity improvements generally.

So I think with -- you recall we had -- we mentioned we had a mechanical failure on that line.

All of those things seem to be behind us now and things are pretty stable with a good outlook for continuing improvement.

So we are pretty pleased with the way that thing is running.

George, would that suggest, assuming the Christmas selling season is not necessarily robust, but good, would that suggest sequential improvement in the D&G margins as we roll through the fourth quarter?

Well, it's all going to depend on volume demand, Jack, but the good news is we are not short of product in that market, and if it accelerates rapidly we are going to be in great position to be able to seize advantage of it.

George, one other question.

If you take a step back and you look at 3M you guys still are tracking towards spending hundreds of millions of dollars in expanding capacity globally.

In last quarter the Decatur line blew up.

How is there -- how do you assure yourself, for a company that has found itself with all these production bottlenecks, that as you spend all of this money and this big capital ramp up over the coming quarters or periods that you can actually have in place the proper control procedures so that there aren't fairly large snafus, if you will?

How do you ensure the proper controls and reassure investors that there isn't risk in place in terms of your expansion plans?

Well, in a technological business, John, you're always looking to make continuous improvement both in productivity and the performance of the product, and obviously the costs.

This is a technological company and we will continue to invest in technology and you will see our basic mantra is how do we design a product which brings higher performance at lower cost and ideally at better margins for us.

That's our long-term goal.

When you push the curve you always introduce elements of risk but there's nothing that we can see at all that would lead us to the conclusion that there's any particularly significant or even marginal change in our risk profile.

So I'm not especially concerned about it, but thank you for the question.

Maybe just lastly, Pat, oil prices are down, you guys are fairly large consumers of oil derivative products and adhesives and other things.

Should those roll through to continued margin improvement, and how would -- is there a way to kind of quantify prospectively the impact?

John, I can guarantee you that we have our procurement people working with the same supplies who asked for increases when it went up, okay, now that it has come back down that we are working that issue, and it shows up in raw material.

We'll see it in some of the transportation surcharges we see and so forth.

So we would expect that it will help us going forward.

I don't have a specific number for you, though.

Does it affect you in the fourth quarter, do you think?

I don't think we'll see much impact in the fourth quarter.

Thanks, guys.

[OPERATOR INSTRUCTIONS] Thank you your next question is from the line of Dmitry Silversteyn with Longbow Research.

Good morning.

Congratulations on a solid quarter.

A couple of questions if I may.

Number one, is if you look at pharma, the cost that you spend to get the pharma business ready for sale I think the impact was about $13 million can you give us a little more color on what exactly you're spending that money on and how much of a run rate we're looking for in the fourth quarter?

Dmitry, first of all, thanks for the congratulations for the quarter.

On the pharma piece.

In the quarter what that is is those are basically retention bonuses that we're paying the employees of pharma to guarantee their employment and ongoing success of that business.

It's actually running very, very well.

So it is -- those expenditures, at least in the third quarter, and heavily in the second quarter, are really retention bonuses to try to maintain those employees until we get a final agreement with a buyer relative to what level of employment they need going forward.

Okay.

In the fourth quarter run rate would be similar?

The fourth quarter for that particular item would be very similar.

Okay.

But as we proceed down the path, there may be other costs associated with the disposition of that business that are not in our estimates.

Got it.

Obviously costs and whatnot are going to be left behind.

You mentioned that you're moving your medical supply chain to lower cost regions.

Are you talking about actually moving the manufacturing plants or expanding your existing ones in low cost region?

Is the strategy there to address the pricing pressure from U.S. hospitals and doctors or kind of what's the reason behind taking this step at this time?

Well, Dmitry, a couple reasons.

It's not just the U.S. putting pretty on -- competition in every industry continues to get higher and higher, so we have to continue to look at where can we provide the lowest cost, best service for some of our products.

So in the case of medical specifically, we are moving to locations that will give us -- in many cases we consolidated manufacturing from multiple locations into a single site, lower cost location.

We continue to, though, also expand production in locations where we're going after growth.

So we've got a combination of things going on.

We've got investment going on for growth, but we've also got investment going on for lower cost manufacturing as well.

So we've got multiple activities going on, not only in medical but in a number of our businesses.

And steadily in the United States as well as those foreign ports where some manufacturing is going.

Thank you.

If I can ask a bookkeeping question what was your depreciation and amortization in the quarter?

Dmitry this is Matt.

We'll get back to you with those details.

Again, could I ask everyone to limit your follow-up to one?

We have quite a few people in queue and we'd like to make sure everyone gets a chance to talk.

Next question, Jeffrey Cianci with UBS.

Great job.

Question on the drugs.

Still in the number -- if I'm reading this right, did drugs grow better than the healthcare segment as a whole?

They're still in the number, right?

If so, is this just easier comps or improvement as you lead into the sale?

I'm trying to get a sense of what '07 will look like in margin and growth without the drugs in there.

Well, yes, that's a good question, Jeff.

No, they're not growing faster than the overall business.

You said 10% growth for the business and you gave us a drug number.

I think it was -- I think we said 8% without pharma.

Right.

And 10% with pharma.

So am I misunderstanding?

No, you've got 6% local currency growth for the healthcare business.

On the local.

Okay.

Got you.

So with them -- presumably there will be a cash item in here, you're comfortable that going to get cash here and we're going to remove some cost?

Can healthcare margins go up notably next year?

Can they go up notably?

No, that would not be the intent.

Healthcare is running in the high 20s, okay, which is a very decent margin, and I would not expect that to be significantly altered.

So you're saying the drug deal is just too small to move the needle?

What you'll see is you'll see quite a bit of difference in the makeup, okay, if you looked within healthcare between gross margin and SG&A expense, because, pharma businesses have very low factory costs, and relatively high SG&A costs.

So if you look at the makeup of it, will change within healthcare, but the bottom line isn't going to be that much different from a margin perspective.

My follow-up is for George and the stock bay back.

Glad to see such a big step-up.

This is a heck of a rate of buyback.

Clearly you can't annualize it, $4 billion a year, but perhaps you can.

Would love your thoughts on this versus dividend increases and what does that imply for buyback versus acquisitions?

Glad to see you've stepped up on it and can we expect after this authorization that this will be a priority use of cash?

Well, I think that clearly when the stock offers a great opportunity, as it did, we were vigorous in taking advantage of that opportunity, and we're constantly going to evaluate the uses of cash.

We'll have acquisitions come up.

If opportunities present themselves to buy more stock back then you'll see that.

We'll also fundamentally, always do, Dmitry, we'll never be, excuse me, with, John,.

Jeff.

Close enough.

Sorry, Jeff.

Forgive me.

Jeff, the thing that we're not going to do is do anything different other than what we've been doing in the past.

We're going to take at least an antidilution position, and then as opportunities allow we'll buy more stock back and we'll do more acquisitions.

So I don't think you should see or expect any change in the pattern that we've had in the past few years.

Thanks.

Thank you.

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

Please proceed with your question.

My questions, of course, have to do with LCD films.

One, I want to make sure I understand the local currency growth in the film business in this quarter.

You said volumes are up more than 20%.

What was price down, Pat?

Well, we've been running at a double-digit price reduction, Mark, on an annualized basis, so if you look at probably the revenue number it's more like a 10% or so.

Okay.

On a go forward basis, let's assume we can look into '07 a little bit in terms of what you see out there for the various applications.

If by company this kind of volume growth against these kind of price down moves, is it still a jewel of the business when you factor in price?

Positively.

It is a absolutely fabulous business.

Even though -- and everything is always relative to how you've performed in the past.

It's a great business, and in absolute terms, we will continue to invest in this space, these kind of profit opportunities.

Finally, is the double wide line running yet and if it isn't when should it be?

It's not and was never intended to be running at this stage.

It will be sometime next year before we even attempt to get that up and going.

Thank you.

Thank you.

Your next question comes from Jeffrey Sprague with Citigroup.

Please proceed with your question.

Thanks.

Good morning, everyone.

Good morning.

I was wondering if we could flush out the acquisitions a little bit.

By nature of their small size, they're not really hitting kind of disclosure levels that allow us to get a good handle on kind of the valuations and the ROIC metrics and things like that.

I'm just wondering first, if you could just give us a little color on that in terms of what you're paying, what the ROIC profile is and what you're expecting the acquisition to contribute over the next two or three years?

Well, I guess, Jeff, there's kind of -- a mixture of deals out there.

The one we made just this past Monday is heavily -- a technology acquisition for a brand-new platform for us around digital dentistry.

That happens to be one that has huge growth potential to us that doesn't have much revenue today.

Just to take one end of the scale.

Versus those that are existing businesses and so forth.

So there's obviously different metrics, but our criteria continues to be that we want to have returns in excess of our cost of capital, primarily because you end up with some leakage in some of the stuff.

So we have got to target returns that exceed our cost of capital.

And importantly, the acquisitions fit the strategic direction of where the Company is headed.

We're not just waiting to see does a deal make financial sense.

If it doesn't make strategic sense we surely don't want to do it.

So we continue to have both a strategic focus as well as making sure that it flows through the proper filter.

So generally speaking, acquisitions don't give you much earnings the first year, the first year out when you have to consider purchase accounting and so forth, but we expect them to contribute in the second year of being around, and then as we kind of indicated that from a top-line standpoint, thus far this year, the deals probably will give us about $400 million of top line.

So that's kind of the way we would see it, and I would see them as being at least the ones that we have done thus far will not be dilutive from a margin perspective.

They follow fairly predictable patterns, some, as Pat said, technology acquisitions, like the Brontes one that we did just this week.

Some are giving us market access, like a couple of the ones that we did overseas, they give us an open door in that marketplace.

So not only can we sell that local brand we purchased, but we can use it as a platform to build and launch our other premium brands into those market places.

In some cases it's just product fill out where, the Biotrace thing that we've been working on is expansion, lateral expansion in that marketplace, good safety, so looks like it's a pretty good one.

In some cases like the Nylons one that we did, Jeff, was pure capacity.

We had demand and this was an easier way to help us solve some of the capacity issues.

So as Pat said they're right down the middle of the field strategically and here and there we'll pop in a slightly larger one like we did with the Passport Printing Company in the U.K., but they're going to be right on the strategic plan, rate in the core of the business.

Just to follow-up on that, as you think about it strategically, the Passport one was a little bit larger, still net-net they're small.

I'm just wondering if you think about the complexion of 3M and the tact that it's a collection of a few core technologies, that kind of vertically go up through the segment.

Does the Company just not lend itself to something larger, kind of a larger platform within the Company, and we should expect really this kind of heavy pace of smaller deals as you fill in and build out, or is there the potential looking out for something a little bit bigger that maybe just skews the direction of the Company a little bit in a different direction?

I think that you're going to see a steady diet of smaller acquisitions that tuck in and give us that sort of nice facility that we're in need of but I don't think you should discount our appetite for one or two sizable -- more sizable acquisitions as and when opportunities present themselves.

And we have worked on a number of those sorts of things, Jeff, and none have come to fruition.

So we've got our sort of double vision on this.

Nice small tuck-ins, but if we can get a nice new sizable product line that fits our company, then so be it.

It could be both.

I'll follow the rules and stop there.

Thanks a lot.

Thank you.

Your next question comes from John Roberts with Buckingham.

Please proceed with your question.

Can you hear me?

Yes.

Just to fill in on that we have got -- of that 350 to 400 million in sales from acquisitions, Pat, there's about 150 to 200 that's safety and security, that's track and trace, and the rest is largely Brontes and Biotrace, the medical stuff?

On the revenue side, I think your read was right.

A big piece of that will be in safety and security relative to the U.K.

Passport business that George referred to.

Brontes really doesn't have any immediate revenue.

Obviously we want to get to commercialization of that technology as rapidly as possible.

But based upon the deals we've done thus far they are heavily geared towards the safety, security piece of it.

Sprinkled in in every one of the other businesses we've actually done acquisitions at least two in every one of our businesses.

Is the target still to add medical revenues basically to offset the pharmaceutical divestment so that that business is roughly similar in size, net-net, once you threw in some of the acquisitions that you're hoping to make?

John, we continue to think very highly of the healthcare space and very highly of the businesses that we currently have.

We think we've got some very, very solid franchises in the medical space, in the drug delivery space, in the dental and orthodontic space, so we think very highly of that area for additional growth opportunities.

So as pharmaceuticals leaves us, that -- backfilling in some of those spaces definitely would be one thing that we have in the back of our mind.

John, think about that -- the Brontes acquisition.

You can see how the dental field is getting more and more technology, or obviously common things that we make but increasingly you're going to see the use of precision inspection, shall we call it, and data gathering for the mouth so you can build bridges and crowns more rapidly at the chair side and finding sort more user friendly ways to gather that data from the patient.

So we are very encouraged and very upbeat about the possibilities of Brontes technology.

From my perspective, although at the right moment, that technology looks sufficiently generic that we can apply it in a number of different other areas around the Company, and that's what we'll do in due course.

So we're very encouraged by that particular acquisition.

Thank you.

Your next question comes from [Michael Riggin with Genis Capital].

Please proceed with your question.

Good morning.

Pat, I was wondering, on guidance for core sales in the fourth quarter seems a little wide at 4 to 8.

I was wondering if you could just talk about kind of what are the puts and takes and given the wide range I'm assuming you're seeing some moving pieces in there.

I was wondering if could you give us some detail around your thoughts.

Mike, don't read any more into it.

Don't try to overanalyze this.

If you look at our track record, we have a tendency to run in that -- in that kind of range.

So don't try to read, well, jeez, there's a specific plan that says I get to 4 versus 8.

Our performance continues to trend more towards the midpoint of that 4 to 8 on an organic basis, and we want to continue to perform higher and higher in that range.

So don't read any more.

Just read as kind of the nature of the business we're in, that in any given quarter you can be at a 4, you can be at an 8, 8 level of sales, depending upon where individual businesses run.

Anything else, Mike?

No.

Seems like a pretty specific question.

Not a great answer, Pat.

Sorry.

There is no specific range.

You look at our track record, Mike.

We don't expect to get off of that track record of our organic growth rate.

But the reality is in any given quarter--.

Let me ask it this way, Pat.

What goes right to get you to 8 sort of within particular businesses, what goes wrong to get to you 4?

Well, you've got a number of scenarios, Mike.

If LCD volumes really perform exceptionally well in the quarter, maybe we'd be up at the higher end.

If a -- if for some reason there's a little bit of a pull-back come December around the holiday season, it could be at the lower end of the range.

I just took the optical film business as an illustration there.

So every one of these businesses has some variation built into it.

Okay.

Thanks.

This is Matt.

We're a little past time.

We want to respect everybody's calendars today.

There's a couple more people in queue.

We'll get back to those people right away, but I want to thank everybody for joining us this morning.

We look forward to a very strong finish in '06, and we'll talk to you very soon.

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

You may all disconnect, and thank you for participating.