3M (MMM) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M fourth quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]

As a reminder this conference is being recorded Tuesday January 30, 2007.

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

Good morning, everybody.

I am Matt Ginter head of Investor Relations for 3M.

I would like to welcome all investors and analysts to our fourth quarter 2006 business review.

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

As usual, today's discussion will follow a series of PowerPoint slides currently available on our Investor Relations website at www.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 statement that is reflect our current views and estimate bes our future performance and financial results.

These statements are based on certain assumptions and expectations of future events 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 CEO will make formal comments about fourth quarter and full year results along with our 2007 outlook and then we will open it up for Q&A.

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

Thanks, Matt, and good morning, everyone.

As you can tell from the complexity of our press release, we have several items to cover with you this morning so let's begin.

Our calendar year and fourth-quarter earnings include a fair number of adjustments, so I would like to take a moment and level set our results so you can clearly understand the underlying profit performance.

I will also explain our forward guidance on a comparable basis which George will further expand upon during his comments.

Our 2006 reported earnings per share were $5.06 per share.

Our strong underlying operating performance drove these earnings, and I will describe this in detail in a moment, but earnings were also impacted by a number of special items.

First, in December of 2006 we sold our branded pharmaceutical business in the United States, Canada, Latin America region, and the Asia Pacific region including Australia and South Africa which resulted in an after tax gain of $674 million or $0.88 per share.

In addition, we incurred employee related severance and asset impairment charges during the year pertaining to the pharma sale itself which in total reduced net income by $114 million or $0.15 per share.

At the same time we incurred restructuring costs in a number of our worldwide staff functions order to lower our overhead costs in response to the sale of the pharmaceutical business.

One-time costs associated with these actions totaled $73 million after tax or $0.10 per share.

By the end of 2007 we expect to have eliminated the entire amount of overhead that had been allocated to the pharmaceuticals business.

We also restructured a number of our other businesses in the fourth quarter.

These actions took the form of asset writedowns, head count reductions or some in some cases we simply exited businesses that lacked strategic fit.

One-time costs associated with these actions totaled $78 million after tax or $0.10 per share.

Next in October of 2006 we acquired Brontes Technologies, Inc., a developer of proprietary 3-D imaging technology for dental and orthodontic applications.

This transaction resulted in a pre-tax and after-tax charge of $95 million or $0.13 per share, reflecting the one-time write of acquired in-process R&D.

Moving along in the second quarter of 2006, as previously disclosed, we recognized an after-tax expense of $25 million or $0.03 per share to revolve the antitrust class action involving direct purchasers of branded transparent tape.

Finally, in the second, third and now fourth quarter of 2006 we recorded net after-tax benefits of $149 million or $0.20 per share from certain income tax adjustments.

It is important to note that approximately $160 million of the total pre-tax charge or $0.15 per share are non-cash charges.

Our first half 2007 cash flows will be negatively impacted by approximately $600 million related to other fourth quarter actions including the taxes on the pharma gain.

After adjusting for these items, earnings were $4.49 per share.

Generally accepted accounting principles prevent us from classifying the pharmaceutical business as a discontinued operation due to the extent of our projected continuing cash flows from our contractual supplier relationship with the new buyers.

Therefore it will create a comparability issue beginning with our Q1 '07 results.

Annual sales in 2007 for pharma were $774 million, and operating income was $257 million, excluding special items, or $0.23 per share.

Many of our operational metrics will look quite different in 2007 as a result of the selling the pharmaceuticals business.

Gross margins will be lower by approximately 1 point, and SG&A will be about 50 basis points lower than in prior years.

R&D as a percent of sales would be approximately 30 basis points lower, and operating margins will be dilutive by about a half a percentage point in 2007.

Total company earnings excluding special items and pharma earnings in 2006 were $4.26 per share.

For 2007 we expect earnings to be in the range of $5.20 to $5.45 per share which includes an estimated $0.60 to $0.70 gain related to January sale of the European pharma business, net of other anticipated restructuring costs.

Earnings per share in 2007 on an apples-to-apples basis of $4.60 to $4.75 are expected to increase between 8% and 12% versus 2006.

Again, George will address our 2007 outlook in more detail in just a few moments.

Please turn to slide number 3.

Here you see a similar reconciliation for the fourth quarter stand-alone.

It compares this quarter's reported earnings of $1.57 per share versus the $0.97 earned in the fourth quarter of 2005.

Again, my objective here is to explain a results on a comparable basis.

The first five adjustments that you see here are the same as those I described on the last chart.

Although there are slight variations in EPS values and certain categories, largely due to accounting differences in average shares outstanding between the full year 2006 and the fourth quarter.

In addition, reported earnings were boosted by net benefits for certain income tax adjustments which added $25 million to net income or $0.03 per share in Q4.

As you may recall, in the fourth quarter of 2005 3M adopted FASB interpretation #47 accounting for additional asset retirement obligations we ordered a non-cash charge of $35 million after tax or $0.04 per share as a cumulative effect of a change in accounting principle.

Taking all of these items into consideration, fourth quarter 2006 earnings were $1.10 per share, a 9% year-over-year increase.

I know this was a long-winded introduction to this quarter's call, but we thought it was important to provide some context around the fourth quarter and full year 2006 results as well as our 2007 guidance before we went any further.

Please turn to slide number 4 where we will examine our 2006 full year performance.

Record sales in 2006 were just shy of $23 billion, up 8.3% over 2005.

Sales increased 7.7% in local currencies, including just over 2 points from acquisitions.

All businesses made positive contribution to growth in 2006 and have done so for three consecutive years.

Reported operating income was $5.7 billion, an increase of 17.3% year-over-year or 7.3% when adjusted for special item and as stock option expense in both years.

Operating margins were 22.6% for the year which includes a negative 20 basis point impact from year-over-year differences in stock option expense.

Option costs were higher primarily due to additional vesting of our 2005 grant along with accelerated expense related to the retirement eligible portion of the stock option expense.

Recall that beginning in 2005 we changed three-year vesting from a one-year vesting in prior years.

We're making even further changes to many of our compensation programs to better align them with our strategic direction.

Importantly, we maintain our strong operating margins at 2006 which was a concern that many of you expressed to both George and me since we first articulated our growth strategy at our investor meeting in May of last year.

Our objective here is unchanged.

That is, to accelerate the long-term growth rate of the company and to maintain premium operating margins and return on invested capital.

Reported earnings per share increased 27% to $5.06.

Excluding special items of both periods, earnings per share increased 9%.

As I mentioned earlier, in December we sold two tranches of our branded pharmaceutical business.

We closed the sale of our business in the United States, Canada, Latin America regions effective on December 31st, and we closed the sale of our Asia Pacific pharma business including Australia and South Africa on December 1st, almost a full month earlier than we had anticipated.

This obviously reduced our sales and profits slightly for the quarter, but of course on the whole we're pleased to do get this done so quickly.

The sale of these businesses resulted in an after-tax gain of $674 million or $0.88 per share.

Also in early January we sold our European pharma business as well.

Many of you know how challenging it is to execute a transaction of this magnitude let alone with three different buyers.

Believe me, our team did one heck of a job closing the deal while keeping the business running to generate maximum shareholder value.

Full year free cash flow was $2.7 billion, down $600 million versus 2005, due primarily to higher capital expenditures and a driving accelerated top line growth along with our higher tax payments.

Finally, return on invested capital was 22.5% for the year which was in line versus 2005.

This is easily more than twice our cost of capital and is a testament to the strength of our business model.

We remain highly focused on accelerating investment to say drive future growth while simultaneously maintaining sustainable and premium ROIC.

Let's dig in deeper to the full year P&L found on slide number 5.

From this point forward the numbers I will discuss exclude special items in all periods.

Sales once again were a record $22.9 billion, up over 8%, and we leverage this had growth into earnings per share growth of 9%.

Differences in stock option expense between years hurt earnings per share growth by 40 basis points.

Gross margins declined by about a point, impacted by higher raw material costs,slightly lower selling prices, and higher costs associated with scaling up additional manufacturing capacity.

We also had some inefficiencies in many of our supply chains that were capacity constrained during the year.

Finally, we accelerated the pace of acquisitions in 2006 which muted gross margins just slightly for the year.

Once these deals are integrated and begin meaningfully contribute to growth, we fully expect positive impacts sooner rather than later.

We increased SG&A expense just over 4%, gaining some leverage in the process.

Importantly, sales and marketing costs increased faster than sales, while administrative costs remained relatively flat in dollars.

As I mentioned to many of you back in May, we are pushing even harder on the accelerator and driving additional overage on our administrative expenses.

We will use this leverage to continue feeding our businesses with focused investments for the front end clearly aimed at customers, programs, new products, and growth.

We invested $1.4 billion in research and development in 2006, an increase of over 6% since 2005.

Operating margins for the year were 22.6% virtually equal to 2005 levels after you equalize for stock options.

All in all 2006 was a very good year for 3M.

We generated record sales, and local currency growth was the highest we have seen since the year 2000.

Profits were also at record levels, and we accelerated growth investments in many businesses while maintaining our top tier operating margins.

Please turn to slide 6 for a discussion of our fourth quarter results.

Sales in the fourth quarter were up 8.6% versus the fourth quarter of 2005.

Operating income was $1.2 billion, up over 4% after adjusting for year-on-year differences in stock option expense.

Both sales and operating income were the highest of any fourth quarter in our history.

Gross margins were down 3 points year-on-year impacted by higher raw material costs, a weaker U.S. dollar, selling price declines and to a lesser extent early stage acquisitions.

One of the bigger impacts this quarter was highly situation-specific, as the dramatic slowdown in the U.S. housing and automotive markets had a significant negative impact on sales and gross margins in a handful of our divisions that sell into these industries.

Operating margins were 21.2% in the quarter which is down 90 basis points versus last year's fourth quarter after adjusting for stock options.

SG&A expense in the quarter was $1.2 billion, about flat versus last year's comparable quarter.

Again, investments in front end sales and marketing programs continue to increase above the bottom line of sales, while administrative costs as a percent of sales continue to decline in the fourth quarter.

R&D expense increased 6.2% year-on-year.

Fourth quarter net interest expense increased to $22 million versus $12 million last year, primarily driven by increased debt levels resulting from our stepped up share repurchase activity in the second half of the year.

The fourth quarter tax rate was 30.3%, down just over 2 points versus the fourth quarter of 2005 , largely due to the U.S. government's long anticipated reinstatement of the R&D tax credit, along with normal year end adjustments that we encounter as we finalize our annual results.

When I say normal, it sounds like a simple effort, but in fact taxes are quite complicated for a global company of our size and diversity, and our team does a great job of optimizing our current tax situation, but we must continue to reduce our overall rate.

Average shares outstanding were down 3% year-on-year largely driven by the step-up in the buyback program in the second half.

Earnings per share increased 9% with year-on-year increases in stock option expense hurting the growth rate by 70 basis points.

Please turn to slide 7 where I will detail our sales performance for the fourth quarter.

As I mentioned, worldwide sales increased 8.6% versus last year's fourth quarter.

Volumes increased 6.8% with organic volumes up 4.9% and acquisitions kicking in an additional 2 percentage points of growth.

Selling prices declined 1%, and currency translation added 2.8% to fourth quarter sales.

We posted strong growth in our international operations which now represent 63% of global sales and are continuing to grow.

Sales were up 12% in U.S. dollar terms with growth in local currencies increased 7.4%, led by Europe at 10.5 and Latin America at 10.2.

Five points of growth in Europe came via acquisitions, with the largest being our August 2006 acquisition of Security Printing Systems Limited, a leading provider of finished, personalized passports and secure cards based in the U.K.

SPSL gives us important technologies that will allow us to deliver a full range of border and civil security solutions products.

China and India also posted solid local currency growth with rates in excess of 20%.

Although we did see some slowing in Korea as the stronger won appears to be hindering exports.

In the United States sales expanded by 3.3% versus last year's fourth quarter including 1.8% growth via acquisitions.

The U.S. growth was held back due to significant slowing in both the housing and automotive industries which we estimate hurt U.S. growth by as much as 3 points.

The most dramatic impact here was in the roofing granules business, as the shingle manufacturers virtually shut off orders in the quarter, a direct result of slower home sales and housing starts along with excess inventories.

Other related areas of softness included retail do-it-yourself, appliances and automotive OEM.

Please turn to slide 8 where I will recap our fourth quarter business segment results.

Industrial and transportation business posted local currency growth of 4.8%, led by the industrial adhesives and tape business and our automotive after-market division which is a leader global supplier of solution to say body shops for vehicle repairs.

On a geographic basis, growth was the strongest in Europe and Asia Pacific.

During the fourth quarter we made two small but strategic acquisitions in the business.

First in November we acquired Global Beverage Group Incorporated, a provider of delivery management software solutions for the consumer package goods industry.

This deal tucks in nicely with our existing high software business.

We also acquired North Star Chemicals, which will strengthen our core adhesives platform.

Operating income in the fourth quarter was $316 million up 6.1% versus last year's comparable quarter.

In healthcare fourth quarter local currency sales increased 8.9% including 1.2 percentage points from acquisitions.

Growth was led by our medical supplies business, a leading supplier of technologies and solutions for hospitals and medical clinics focusing on infection prevention and acute wound care.

We also drove outstanding top line growth in dental and orthodontic businesses.

Our latest innovation in this business is called Lava, a digital dentistry system for producing crowns and bridges.

Healthcare was also busy on the acquisition front, closing three deals in the fourth quarter.

In addition to Brontes technology, we also acquired Biotrace international PLC, a U.K. based manufacturer and supplier of industrial microbiology products used in food processing, safety, healthcare, industrial hygiene, and defense applications.

Finally, in December we acquired Soft-Med Systems Incorporated a pryer of health information systems software and services that improve the workflow and efficiency for healthcare organizations.

As I mentioned earlier, our healthcare team successfully completed the sale of the pharmaceuticals business in the Americas and the APAC during the fourth quarter followed by the European leg in early 2007.

It goes without saying this team had a very busy fourth quarter in positioning the portfolio for accelerated growth into the future.

Healthcare operating income increased 6.7% to $304 million.

Looking ahead, operating margins in 2007 in healthcare will be negatively impacted by the sale of our branded pharmaceuticals business by almost 2 percentage points year-on-year.

Moving onto display and graphics, local currency sales growth was 3.6% in the fourth quarter and profits declined 7.7% to $264 million.

Year-on-year differences in stock option expense hurt profit growth by 1% for the quarter.

Top line growth in this business was led by the commercial graphics division, a leading global supplier of large format graphic solutions that cut across a broad range of industries.

If you're not familiar with this business, pay attention next time you see a large graphic image on the sign of a semi trailer, a bus, a train or the side of a building for that matter.

Chances are you will be looking at 3M materials.

We also posted solid mid-single digit growth in our traffic safety systems business.

Optical film delivered fourth quarter sales -- record fourth quarter sales as unit volumes increased at double-digit rates driven by continued exploding consumer demand for LCD TV's.

As anticipated we're seeing more seasonal fluctuation in this business, and in fact demand for proprietary optical film and components began to moderate towards the end of December.

Selling price declines were in line with our expectations, and margins were similar to recent quarters.

Margins are down, however, versus a year ago levels, consistent with what we've described on recent quarterly conference calls, driven by the significant mix shift to large format LCD TV's which should constitutes about 40% of total LCD film sales.

Margins have stabilized in LCD films, production yields are improving, and we're aggressively working to further capitalize on the expanded capabilities of our new film capacity.

This multi-layer optical film equipment is designed for double the width and faster speeds than its predecessors which is another critical competitive advantage for 3M in this high growth industry.

One other item of note on pricing, we saw increased pricing pressure in our traffic safety systems business as one of our competitors attempted to grab additional market share in Asia.

This occasionally happens in that industry, but as a low cost producer, we have the ultimate advantage.

Fourth quarter sales in consumer office were $824 million, a 5.6% increase in local currency terms.

Holiday seasonal demand for our power brands such as Scotch Tape, Post-It notes and O-Cel-O sponges was strong in the mass retail and wholesale channels.

Perhaps the most notable change in sales trajectory in consumer office occurred in our construction and home improvement division which sells a broad range of consumer products into the retail DIY channel.

After posting outstanding double-digit top line growth for many of the past several quarters, growth moderated to a mid-single pace in Q4, and of course the business wasn't nearly as profitable as a result.

There is no doubt that the housing slowdown is affecting sales in this channel.

We certainly expect the situation to improve as 2007 unfolds, but the precise timing when this happens is difficult to forecast.

Our visual systems business which traditionally has offered analog, overhead and electronic projectors and film posted a sales decline which hurt the overall consumer and office sales growth by over 1 point.

Our team here has done a miraculous job of reinventing themselves by introducing a number of digital projection solutions just beginning to reach the market.

There are no guarantees in this challenging space, but we have some outstanding technology that we believe is worth a shot.

Operating income in consumer office was $141 million or flat versus last year's fourth quarter including 1.2% year-on-year penalty from higher stock option expense.

Sales in our safety security and protections services business were $655 million, up 12.2% in local currencies, 10 points of which was due to our August 2006 acquisition of Security Printing and Systems Limited, the U.K.-based security technology company that I mentioned earlier.

Fourth quarter operating income grew 1% versus last year's comparable quarter including a negative 1.5% impact due to higher stock option expense.

As has been the case for some time, our occupational health and environmental safety business continue to be a stalwart in our portfolio growing at double-digit rates in the fourth quarter.

Organic growth in this business was driven once again by strong global demand for personal safety products, particularly in respiratory protection.

We also posted outstanding growth in our corrosion protection business, in excess of 50% in fact.

This is truly a great business that supplies coatings for all types of commercial and industrial applications across a broad spectrum of industries including oil refining.

However, the story of the quarter in SSPS was the roofing granules business.

The shingle manufacturers completely missed the forecast in the fourth quarter.

As a result, we went from producing all-out and incurring premium costs to meet excess demand early in the year to being virtually shut down in Q4.

As a result sales in this business declined almost 50% year-over-year.

Excluding the impact of this slowdown, operating profit in safety security and projection services would have expanded by approximately 20%.

The top line rate would have improved by about 7%.

In electrocommunications local currency growth was 2.6% versus last year, including 2.2% from acquisitions.

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

Tempering growth in the fourth quarter was softness in our flexible circuit business due to a number of applications that went end of life.

Operating income was $110 million or down 2.4% year-on-year.

Year to year differences in stock option expense hurt profit by 1.5%.

For some time E&C has been absorbing some large underutilized facilities, and we took action in the fourth quarter to get them behind us.

In fact, of the business units specifically restructuring assets that we took in Q4, two significant items were in the E&C business.

These actions will make them much more competitive as we move through 2007.

Please turn to slide number 9 where I will review a few balance sheet and cash flow metrics.

Networking capital turns were 5.4, up 0.3 turns versus the third quarter, and down 0.3 turns versus the fourth quarter of 2005.

Capital expenditures totalled $405 million, an increase of $122 million year-on-year and $93 million sequentially.

Total capital expenditures for 2006 were just under $1.2 billion, up $225 million versus 2005 as we invested in a number of growing and highly profitable businesses such as medical, respiratory protection, blue masking tape, filtrate filters, LCD films and others.

Free cash flow in the quarter was a solid $917 million.

Dividend payments for our shareholders were $339 million, up 6.6% versus the fourth quarter of last year, and we repurchased $330 million of our own stock during the quarter.

Weighted average shares outstanding were down about 3% year-on-year both for the fourth quarter stand alone and for the year in total.

At the end of the fourth quarter we had approximately $750 million available of our existing authorization that expires on February 28th.

During 2006 we contributed approximately $350 million to our worldwide pension plans and had another solid year of double-digit asset returns in our U.S. plan.

On the liabilities side our discount rate increased by 25 basis points, thus reducing our projected benefit operation.

Our U.S. funded status stands at 99% up from 92% in 2005 and on a global basis we are 96% funded.

Our return on asset assumption remains 8.75, and as I mentioned we're increasing our discount rate 25 basis points to 5.75.

In September 2006 the financial accounting standards board issued SFAS 156, employers accounting for defined benefit pension and other post-retirement plans.

This standard requires employers to recognize that underfunded or overfunded status of defined benefit post retirement plan as an asset or liability in the statement of financial position.

As a result of the implementation of 158 the Company recognized an after-tax decrease in accumulated other companies of income which is part of stockholders' equity of approximately $1.9 billion.

This decrease in the fourth quarter of 2006 is primarily due to the prefunding of our U.S. plan.

The adjustment impacts the balance sheet only with no impact in net income or cash flows.

For a complete details please refer to this morning's press release.

Finally, our debt to cap ratio is 26% at the end of the fourth quarter.

This concludes my review of the fourth quarter and full year financial performance.

Now I would like to turn the microphone over to George.

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

In May of last year we outlined a four prong strategy to reinvent 3M and change it into a faster growing, faster moving, and more competitive global company.

While we still have a great deal to do yet, and it is not an easy challenge, I am personally very pleased, very pleased indeed with the progress we made in 2006 toward the goal of sustainable higher growth.

Sales in local currencies are up 7.7% in 2000 versus 2005 which has the highest growth rate we've seen at 3M this decade and the highest mid-cycle growth we've seen some many years.

The people at 3M are responding to the growth challenge that we've set them.

We achieved this growth rate by confronting this realities about the portfolio and our historical investment patterns while formulating a straightforward strategy for growth which we shared with you in May and by taking sensible steps in rekindling our investment in the future.

I can say that our employees have wholeheartedly embraced our new focus on growth.

The issues have to be addressed in any company driving growth are both cultural and financial, and we've been addressing both.

One of the two or three most significant financial steps we took in '06 was an increase in R&D expenditures by over 6% to position our existing portfolio for accelerated growth.

This increase is over 8%, in the core considering we simultaneously reduced spending in pharmaceuticals.

We made significant technology moves for the future, notably, one, the acquisition of Brontes Inc., the premier technology solution provider in digital dentistry, and as a key bridge between accurate and fast data gathering and share site direction for bridges and crowns.

This acquisition was the most important platform we have built since purchasing ESPE many years ago.

Secondly, we launched five new emerging business opportunities, or EBOs as we call them.

We achieved great traction in our track and trace initiative where we merged a number of efforts into one single growth engine for the future.

Significantly, we made important inroads in applications to medical, food and aerospace industries in 2006.

Our global mining EBO where 3M is bringing its vast array of technologies and solutions to an absolutely massive industry.

Safety, which we bolstered by one or two small acquisitions; filtration, which had been previously headlined by Cuno.

Energy, where we realigned several units to focus this great market.

As many much you know a major impediment to long-term and short-term growth for 3M have been capacity constraints in some of our businesses.

When we began this growth journey in 2006, we began by vigorously addressing those capacity constraints.

For example, in medical tapes and drapes, respirators, optical films, industrial tapes, and in roofing granules.

We had numerous product lines totally out of capacity, some working 7 by 24 shifts in an attempt, often forlorn, to keep up.

Simply put, we've been putting our money where our mouth is as demonstrated by an increasing CapEx of 25% in 2005.

When factories get beyond about 95% capacity utilization, the overtime costs, expediting freight and emergency repairs generally drive margins down on an incremental volume, not up.

When demand is overseas, and your plant is in the U.S., it just makes the situation more difficult.

This high level of capital investment will address two objectives.

First, meeting the immediate need for capacity in businesses that are constrained and providing a platform for greater organic growth, but second beginning addressing the longer-term necessity to simplify and streamline our supply chains; better for our customers and better for us.

A streamlined supply chain will ultimately help drive growth of lower costs and much lower working capital.

So we're using these capacity expansion to say simultaneously straighten our convoluted supply chains.

Along with G&A leverage and growth, more efficient supply chain is the big nugget of opportunity for our company.

A great early example of this kind of investment is in our mask respirators business.

We expect to open a new manufacturing plant in mid-year 2000 in Korea that will supply the rapidly growing Asian respiratory protection market.

It will be the fastest we have ever built and opened a new plant of this scale in our history.

We also made a large complementary investment in an existing plant in the United States.

Please remember we've not yet seen the benefit of these investments in our sales or our earnings, but we are now bearing the investment costs.

While the first new plant in this sequence of investments has yet to come on stream, we will begin to see some of these churning out product beginning in the third quarter of 2007.

We're planning these meticulously to make sure we do not suffer any serious start-up challenges, though as a practical matter there are always unabsorbed costs and issues in any plant start-up.

It is the nature of the beast.

In 2006 we continued to build our capabilities in many of the world's fastest growing emerging economies.

We began construction of three new plants in China, one in Russia, one in Poland, one in India, and have been working on acquisitions in Turkey.

By the end of 2007 we will have ten or more plants open or under construction in China.

We also drove outstanding growth in more developed economies.

For example, European saw sales growth was about 10% in U.S. dollars and 8.3% in local currencies.

I am especially proud of the fire we lit under acquisitions in 2006, closing 19 deals during the year versus four last year, all contributing to growth in different ways.

Acquisitions are really only about volume.

In our case there were product additions and gap fillers to expand our offerings and become more important to our customers.

Both Biotrace and SSPL in the U.K. fitted that mold.

Capacity additions were another factor in our lineup of acquisitions.

We did one of these to instantaneously expand manufacturing capability and meet surging demand.

Nylons was an example of this kind.

We will do more of these if we could because these are very efficient ways of getting good growth.

Getting access to local markets via local brands was another.

Locals most often want to buy local brands, and we did this through acquiring Pump, a Brazilian maker of industrial ear plugs and hearing protection products.

It is also a good low-cost source of product worldwide.

There are several others like we're that we're working on.

Technology additions were also part of our acquisition strategy in 2006 to augment our existing base with those of the future and doing so in considerably less time than it would take to develop our own technology.

The previously mentioned Brontes is a prime example of this.

So, all in all I am very pleased with our progress on the growth front.

Every journey that we say meets the occasional bump in the road, and we met some, too, in 2006, so we had our share of challenges.

Some of them were self imposed while others were imposed by market forces beyond our control, but we learned the hard lessons and are making the necessary cost corrections.

Take our Q2 experiences with the LCD film business was an example.

This was clearly the toughest challenge in the year.

Our experience in that quarter reinforced the need not only to understand better the pipeline and pricing dynamics of the sometimes volatile consumer electronics industry, but also more importantly longer-term to develop significantly broader growth opportunities across all of our portfolio and to aggressively develop a new growth platform for the future.

We are working on that issue vigorously.

A company like ours cannot be reliant on a single growth engine.

In the fourth quarter sales growth was towards the lower end of our forecast.

This was not at all like Q2, as all the reasons were market driven and caused mainly by a low housing unit, while we're at the back of the production line supply chain.

Roofing granules was a major factor here and significantly affected our sales growth and income.

This one manufacturing unit alone cost us $0.05 per share in earnings in the second half.

Automotive has also become significantly noticeably lower as the quarter went on.

Though it impacted three of our reporting segments, none of this housing slowdown related to the fundamentals of our business; all were self imposed.

It was all externally market driven.

We gained share, but it was not enough to overcome contraction in volume.

We absorbed these economic movements and more besides and still delivered reasonably good earnings growth for the quarter.

Once again, it underscored our resiliency but it also emphasized the need to reinvent ourselves and shift some of our portfolio towards higher growth markets.

We got a tremendous amount of things done in 2006, and I would like to list just a few.

We got a new strategic plan figured out, communicated, and accepted by our colleagues.

We got our pharmaceuticals business sold which in my mind was a monumental task.

We got the 3M growth engine going again.

We got much needed capital applied to lubricate our capacity and supply chain problems in many areas around the world.

We also invested more heavily in R&D.

We got a new compensation and options system in place and a well-oiled acquisition machine under way; quite a set of achievements I would say.

These, and much more besides, were all down from a standing start in 2006.

There are only a few huge amount of things we got done, and I think everyone who contributed to them at 3M should feel justly pleased with our progress.

It is important to understand how 2006 unfolded, but it is more important now to articulate again where we're going in 2007 and beyond.

As I told you at our investor meeting in May of last year, we're absolutely committed to growing 3M at a faster pace using the four-pronged approach.

Reinvesting in the core, developing adjacent EBO's, expanding on our already world class capabilities outside the United States, and by acquiring companies in faster-growing industries, and as I explained previously we're charging ahead on all of these fronts.

Transforming 3M into a faster-growing company will of course require changes to the way we manage the Company.

While it is our clear intention to invest in the future, we expect to do so while maintaining operating margins at or near current levels.

During the transition period investments will not always be synchronous with margin improvements, but ultimately capacity, a fast supply chain and more R&D are the key bridges to a future of sustainable growth and superior margins for 3M.

Please turn to slide 11, entitled "2007 Full Year Guidance".

As for our formal outlook for 2007, I see a year of plenty of challenges.

Some internal, and some external, but none that will steer us off our long-term course.

Taking pharmaceuticals out of the sales basis since it's now been sold, we expect to generate local currency sales in the range of 6% to 10% in 2007 including the carryover of acquisitions we did in 2006.

New acquisitions in 2007 will be an unknown additive perhaps adding another couple of points or so.

Having some pharmaceuticals sales in the 2006 base will create about 3.5% to 4% of drag on our sales growth rate throughout 2007. 2007 earnings are expected to be in the range of $5.20 to $5.45 per share, including an estimated $0.60 to $0.70 per share gain due to the sale of our pharmaceuticals business in Europe net of known one-time charges.

Excluding these one-time items, we expect earnings to be in the range of $4.60 to $4.75, and as Pat mentioned on his first chart today this translates to approximately 8% to 12% earnings growth on an apples-to-apples basis.

We also plan to repurchase our shares at at least a level that provides dilution from option grants.

In the broader context, recent history should be a guide.

By now I am sure you noticed we're providing annual guidance only.

There are several reasons behind this decision, which was arrived at after a lot of consideration over a long period of time.

It was under consideration well before I arrived at 3M.

First and foremost we managed 3M to create long-term sustainable value.

Second, 3M businesses tend to be short cycle in nature, and we sell a fair amount through distribution, both much which can at times make it challenge to go precisely predict sales.

When you combine this with our standing profit margins, Matt will tell you our earnings can easily move randomly by a penny or two not due to any fundamental reason just perhaps a key customer or two deciding to accelerate purchases in the current quarter or delay them into the next.

A third reason is the volatility of quarter over quarter tax rates, a recent phenomenon for most-used businesses will probably be made harder by FIN 47 and make it for difficult to predict the output of a penny or two of EPS in one quarter.

Finally, many of you have told us, in some cases with a fair amount of passion, that providing quarterly guidance unnecessarily creates unnecessary volatility in our holdings and is frankly inconsistent with your investment objectives which are generally longer-term in nature, so we listened to you.

We will still be setting tough quarterly internal targets, and we will still give you general indication of how we expect the quarter to go.

So nothing has changed on what we expected ourselves.

As Pat and I continue to remind our team, if you want to be rewarded in the market, have you to be highly profitable and you have to grow.

Investors expect to us maximize the return on capital invested in 3M, and we expect nothing less from our team, plain and simple.

Looking and anticipated earnings trajectory in 2007, the first quarter will be the most challenging of the year for several reasons.

First we expect the economy will grow more slowly than it did in the first quarter of 2006, and 3M participates in the global economy, too.

We're not immune.

Second, LCD TV industry was running flat out in last year's first quarter.

Production levels far in excess of market needs.

We saw the back side of that sword in Q2.

Industry now appears to be much more stable and likely to continue solid into 2007.

However, it does create a difficult year-on-year comparison for us in Q1.

Finally, while we aggressively restructured many areas of 3M in parallel with divesting the pharmaceuticals business, the great majority of those costs will not go away until late in the first quarter or early in the second.

So our plans call for earnings growth to be the slowest in Q1, to pick up speed somewhat in the second quarter, and to accelerate even further in the second half of the year.

Overall we are pretty optimistic about the year in full 3M.

Operating margins are forecast to be in the range of 22% to 22.5% which if you adjust for the divesture of the accretive margin pharma business as our stock option expenses increases in 2007, this would be about the same as our premium margins we achieved in 2006.

The effective tax rate for 2007 is expected to be between 32.75% and 33.75% which is higher than 2006 due primarily to the United States government's repeal of the Extraterritorial Income Exclusion, also known as the FSC, which was previously granted to U.S. exporters.

As a leading U.S. exporter, the loss the FSC legislation has a fairly significant impact on the company's tax rate.

The government is replacing the FSC with a new manufacturers credit which will phase in over the next several years.

In addition, the Company will implement FIN 47 in the first quarter of 2007.

We expect the impact of this new accounting standard will put upward pressure on the Company's tax rate in 2007 and as I mentioned, will cause more volatility in the tax rate over time.

Our internal plan, however is to reduce the effective tax rate by approximately 1% each year beginning in 2008 through investments and structure.

Like our competitors, we expect to give tax planning much more emphasis going forward than it has been given at 3M in the past.

Capital expenditures are expected to increase from this year's $1.2 billion to something in the range of $1.4 to $1.5 billion in 2007 with the majority aimed at accelerating top line growth in many of our core businesses.

In fact, we have in the neighborhood of 15 significant plant constructions efforts underway as we speak, some adding to existing facilities and a few of the greenfield variety.

Overseas we're building respiratory plant protection capacity in Russia and Korea, medical product plant capacity plant in China an LCD film plant in Poland, a braisers and tapes capacity in China and India, and chemical facilities in China, and a new oil pipeline coking plant in Russia just to name a few.

This is backed up by similar investments in the United States.

Most investors know we're revamping our compensation programs at 3M to align employee and shareholder interest more closely.

The principle effect here is a reduction from 1.5% equity issuance to about 1% each year which now brings us in line with the rest of 3M, U.S. industry.

Associated with that change was a buyout which will result in one more year of increased stock option expense in 2007.

This cost will flatten out in 2008 and then begin to decline in 2009 as we issue fewer stock options in the future and amortization gradually falls off.

So that about wraps up our formal comments for today.

Let me conclude by reminding you that our mission remains the same as I spoken about many times before -- namely, to accelerate growth at 3M, seems like we're doing that, and to do it by stimulating innovation and to support it by driving continued productivity, and of course to focus on building great fundamentals and to execute well in what we think will be a good 2007.

Now we would be happy to take your questions.

[OPERATOR INSTRUCTIONS]

Your first question is from the line of Steven Tusa with J.P. Morgan.

Good morning.

Good morning, Stephen.

I want to get clear -- what are the after-tax proceeds from the pharma sale?

$0.88 is the gain on the transactions, and then there are exit costs associated with the deal, Steve.

Ultimately what are you going to be bringing in and how do you assume that's deployed throughout the year end guidance?

I am sorry, repeat the last part of that.

How much are you bringing in here and how do you -- what do you assume in the way of deploying that capital in your guidance, you know, are you buying back some stock, paying down some debt, how do you assume that you guys deploy that capital in the guidance?

For our '07 expectations and of course we haven't exactly decided, you know, as the year unravels, Steve, we'll ultimately decide, but in our guidance, we've got a range there.

What we have assumed thus far is we will invest it effectively to buy down the CP that we had at the end of the year is what we'll do.

Okay.

Then as far as share buybacks for this year about in line with what you did in 2006.

We will do no less than anti-dilution.

If you look at our past two years, we bought back in the order of, something in excess of $2 billion.

We're not ready to commit what our repurchase program is going to be.

It will be some place probably between those two.

If I strip out that charge in R&D, it looks like R&D as a percentage of sales was actually down a little bit.

You talked about that being up 6%.

You know, is that account going to move up along with SG&A a little bit more over 2007 and 2008, maybe as you start to get some of the benefit from the early investment, you start spending a little bit more, because it still appears you really aren't throwing the kind of money at these businesses as you've been alluding to on these conference calls.

Steve, our spending was up 6% but obviously as a percent of sales going at 8 hasn't exactly kept up.

In George's comments, he also mention that had we also started to scale back some of our pharmaceutical R&D work during the year when it became evident what we're going to do with that business, so when you actually look at how much money we plowed back into the rest of the business, about 8% growth, and we will continue to invest in R&D.

Now, if we can get the top line to grow in light of what our guidance is, to say that we need to necessarily increase the percent of sales, you know, we're not necessarily saying that, but we will keep plowing money into R&D.

Okay.

One, sorry, last very quick one.

Ex the display and graphics business, just generally where did Asia fall out with regards to core sales growth?

Do you remember that?

I think you reported 5%.

Let me just quickly see if I can get at that number.

I know I got it here some place.

See if somebody has that.

It would be, probably, if you look at total revenue, total revenue in Asia would probably be up about 10%.

Great.

Thanks a lot.

Appreciate it.

Thank you.

[OPERATOR INSTRUCTIONS]

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

Good morning.

Thanks for taking my question.

You're looking for 8% to 12% growth this year in earnings, and I am just wondering if you could perhaps think out even further, maybe to '08 and think about the acquisitions that you're doing, you know, a little more in R&D?

You certainly picked up the CapEx that you're spending, and what's your sort of long -- a little bit longer term goal here in terms of growth?

Thank you, Mike.

We have in fact doing what you said.

We pumped a lot of money into plant capacity.

That begins to come on stream in the earliest on stream in the middle of this year.

There is a sequence of plants open up until about the first of, first quarter in 2008.

So I think we can probably expect without me sort of painting myself into a corner on precision, a couple of points of extra growth will probably come from those new plant openings.

On the R&D front you can well imagine that R&D has a little bit more tail to it.

It is a little harder to forecast on when the delivery of any growth from R&D will come, and sometimes you're even using it to defend the core and not just elevate growth on the top line.

I think we should see by 2008, Mike, I think what we'll see our growth rates again with the acquisitions probably accelerating 2% or more than the band that we're talking about this year would be my best expectation.

Okay.

Just as a follow-up, a little bit more near term, given the issue of the housing market in North America, I am just wondering if you could comment on whether there has been any pick up or improvement that you've seen so far.

I realize it is very early in the year in the roofing area, and maybe also in auto.

Well, let me attack it a couple different ways if I can, Mike.

First of all, just to level set everybody, in our roofing granules business, about 70% of volume is dedicated to replacement roof sales and only 30 to new construction.

We think we've been going through an inventory correction in the supply chain.

There was a hold back in the single substrate manufacturers because it was oil based, and they were expecting oil prices to go down.

What we imagine is we're probably run relatively flat in sales in the first quarter until the balance of an inventory has been worked off, but then we think we'll begin to revert to a more normal pattern where sales volume will increase, again more reflective of the replacement and perhaps at some stage thereafter picking up a little bit of extra volume from new roofing work that is coming through the pipeline.

If you have just got to remember, Mike, that we're at the back end in all of our construction work we're at the back end of the chain, you know, in our consumer and office business which call the chain as the division that serves that market there.

We're in paint and dry wall.

You're right at the back end of the process there.

In roofing we're a little further up the process, so I think we went in last in this particular hole, and I think we're likely to come out last relative to some other manufacturers, but I think that there will be stability this year is what the numbers look like, and probably the housing market picking up, I believe, toward the end of this year.

Thanks for the help.

Thank you.

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

Thanks.

Good morning.

Good morning.

So $0.23 of pharma dilution, those are the numbers we have, but my understanding is you're keeping a couple hundred million of contract manufacturing, and, Pat, just based on your commentary that you will pay down CP with $700 million of net proceeds after these other costs, isn't it really closer to $0.15 dilutive?

Like shouldn't we still be getting a $0.10 contribution from this stuff in 2007 yet you're showing zero contribution?

No.

John, we didn't necessarily say we're showing zero.

We got a bad echo here in the room.

What we're saying is that when you take our 2006 results and you back out the reported results for pharma is $0.23.

That gives us a new baseline for '06 at $4.26.

And that as we look at our business as a whole including all the factors and all the assumptions that George laid out, you know, our assumption is we'll get, you know, in that 8% to 12% growth range with, including the cash flow of the business next year.

Okay.

So back out $0.23.

I understand that.

So if you would redeploy the proceeds and then have you contract manufacturing business, how much pharma does pharma in that basis contribute to '07 embedded in your $4.60 to $4.75?

First of all, John, the supply contract for the ongoing operations will be at a significantly lower profit level than the existing pharma business, so it will not be -- from that standpoint it is a, you know, the impact of the supply agreement will not be material from a bottom line earnings perspective.

Okay.

I want to ask you about your forecast top line guidance, the organic 6 to 10.

The midpoint, 8%, is actually higher than the 5 to 8 mid-point that you had been articulating most recently, yet you have now described a scenario where 3 points of drag is coming from housing and auto.

Are you telling us the apples-to-apples is really 9 to 13 ex autos and housing, and number two, why are you taking up the mid-point of expectations given the circumstances we're seeing today and the very weak first quarter that you are articulating?

John, let me make sure we got the numbers kind of squared around.

First of all, the 6 to 10 for everybody excludes the pharma drag which is about 3.5 to 4 points every quarter is going to be a little different than that, and that includes acquisitions in that number.

Okay.

Okay.

If you recall back to the 4 to 8 that we have been providing guidance or 5 to 8 on a longer term basis that was, in some cases, without acquisitions, so we really haven't moved it.

We've moved the bottom end up just a bit, but the top end stayed where it previously was.

Okay.

So 5 to 8 is still basically your expectations this year weighted significantly to the second half?

John, one of the things, though, is we changed the strategy in the Company around acquisitions, so we do want people to get a little more focused on acquisitions will become a more important part of our strategy going forward, so that's why we want to get people starting to think about the a little bit the higher end number.

Now, of course the thing is a little more difficult to forecast what acquisition growth rate is going to be as we know what it is based upon the deals we've already signed, but obviously new ones we won't know until we actually get there.

John, one follow-up, too.

This is Matt.

You quoted a couple hundred million dollars from the supply agreement.

Yes.

If you see in the press release it is really closer to $100 million.

$100 million.

Okay.

Just finally here, I mean optical films, I am assuming just based on display and graphic results, optical films total revenues were down in the quarter driven I guess by the lower production rates expected by the industry in the first quarter.

Despite the very strong Christmas selling season, I guess, George, are you thinking -- why not sell this business?

Why not sell the roofing granules business?

I am just wondering if the disappointments in these businesses doesn't advance your thinking a little bit in terms of possibly making divestitures to strip out some of the profitability of the portfolio.

I think, Jeff, you can imagine we've been looking at all sorts of things.

We haven't reached any final conclusions, and there is also some other issues.

It is not just volatility.

These businesses cross-link with the technologies of other 3M businesses.

For example, on that basis you might conclude that a roofing granules business was not quite so core, but I think you'll find the problem with the optical systems business, John, it's the incredibly woven infrastructure that it has inside 3M.

Technology wise, pilot plant wise, manufacturing plant wise, it really is -- anything can be done, John, but it is extraordinarily difficult challenge, far more difficult than you ever consider in pharmaceuticals.

By the way, it is a great business for us.

It has been a great growth business.

It spawned many of the businesses, and while you have not seen many of these new products coming out, there are lots of stuff this business is creating that we believe in due course will provide us new platforms going forward, so I am going to be very careful not to want to kill the golden goose too quickly.

I understand.

Just as a suggestion, I think it would be helpful to all of us if you can consider a couple of focused analyst meetings this year, not a four-hour everybody gives their speech but diving into a lot of these business that is really are a lot of really are black boxes to an awful lot of us.

Thank you.

Thanks, John.

We do have a couple of those things we're thinking about just in answer to your questions.

[Operator Instructions]

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

Good morning.

Good morning.

George, just one broad-based question, and you've addressed aspects of it, but if we look at the organic growth this year of 6% to 10% excluding pharmaceuticals and 1.5% coming from acquisitions, it is a very healthy growth rate.

If we look at your margin assumption, it is 22 to 22.5, down from 22.6 in '06.

I think the 22.6 included pharma, so maybe there is a 50-basis point hit from that in '07, so the question really is very good volume projections, 6 to 10, and margins essentially flat, and I would have thought that given the good top line performance there would have been more leverage on the margins.

Could you just in broad terms maybe address that?

Yeah, sure, I would be happy to, Jack.

First of all when you do the numbers our pharma business was accretive.

It was accretive -- slightly accretive to healthcare, so when you take that out you see some dilution in the overall margins.

Even in our other big platform business optical systems division, we've seen some decline in operating margins as pricing pressure and technology changes have brought that about.

They are the two primary pressure points in that equation, Jack.

We have seen this year heavy material price increases that we haven't always been able to get back in price, so that's a factor, and I just remind everybody that we're investing heavily in R&D and a lot of these different businesses, so I think when you come out -- Pat and I when we looked at these numbers, when you put all of those things in the pot and stirred them, we actually walked away fairly happy that at this stage of our revamping of 3M, Jack, that we're in the situation we're in.

Now, I don't disagree the implication of your question is so, fine, George, what comes next?

Clearly as the investments take hold and we get supply chain shorter, more R&D coming on stream, we ought to be able to see -- the expectation would be those margins would then be able to tick back up a little bit.

Okay.

Just on LCD film, you characterized the pricing decline similar to prior quarters, so should we be thinking about an annualized 13% to 14% price decline?

Jack, Pat here.

We really haven't deviated too far from the 10 to 12 range, so I think if you think in that range, I think you will be okay.

Okay.

And then just the double-digit numbers subscribed to LCD, is that revenue or in volume?

That was a unit volume.

Unit volume, so in revenues we should --

Revenues you would have to factor by the price change.

That would be a single digit number then, on the revenue?

Yes, it would have been.

So, that's a bit of a deceleration from the third quarter, and maybe that gets into, George, your comment that things slowed at the end of the fourth quarter?

Yeah, and you know what's happening, Jack, here is I think we should see some of this sort of profiling is actually quite positive.

I think when we first talked about this in a less pleasant environment which was in the second quarter, we went through that sequence that the fourth quarter is essentially a sell-through quarter, the first quarter is kind of a bit of a sell-through in a sell-in quarter, third quarter is sell-in, and the fourth quarter is a mixture of sell-in and sell-through.

The tail-off of sales towards the end of the fourth quarter I thought was very responsible thing for these manufacturers to do.

It stops us having sort of first quarter wash over and a lot of inventory out there that's not selling.

I thought this whole thing was very well done and seems to be evidence to us of the more -- that mature approach to the market now emerging.

Great.

Just last question on free cash flow.

It was down in '06 to 2.7, CapEx this year is going up 3 to $400 million.

Should we expect that number, Pat, to decline by a couple hundred million dollars this year from the 2.7?

Cash flow is going to be a very tricky situation, Jack, in '07.

If you look at it from cash received, it will be a slightly different story.

In my comments early just to level set everybody, the way the California flow statement is going to read, Jack, is that the proceeds from pharma shows up in a category that's non-free cash flow yet.

Tax payments, severance costs and so forth will all be up in the cash flow statement.

Our cash flow statement for '07 is going to be a little bit more difficult to unravel, and we will help you do that as we go through '07, but if you think about it more from an underlying perspective, we will continue to invest more in CapEx than our D&A rate is, so we will have less than what our net income is during the '07 year, but that's --

Thank you.

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

Thank you.

Good morning.

Hi, Dave.

Good morning, Pat.

Should optical film margins be up in '07 given the hit you guys took in Q2?

I guess, Dave, that's a changing world.

As I look at it, I think the margins in that business have started to somewhat stabilize, okay, coming out of the second, you know, the second quarter, but of course it is down from a level that was previously in place.

Now, the over impact of course is that TV mix will continue to become a larger and larger percent of that business, and they do have as we mentioned on the second quarter call a lower margin today than some of the other applications do, so as TV's continue to expand, the margin percent anyways in that business will probably continue to come down, but absolute dollars as the volume goes up, you know, probably won't be that different.

Dave, just let me chip another comment on top of that.

We have some experiments going right now that could possibly lead to lower manufactured costs of these kind of products that will help from time to time offset the pricing pressures that we see on a regular basis.

So I don't believe that, we don't think these things are certainly not going to go down, but it is also going to depend on the damage of pricing and cost reductions when those things come in and go out as to what actually happens, but I do think we got the technological means now to help support and underpin these margins not going down very much more.

Understood.

George, just on the sale of the investment in the front end sales and marketing, how much longer will that grow faster than top line sales growth?

You mean for films, Dave?

Overall 3M.

Oh, well, I think that's pretty difficult to estimate precisely candidly speaking.

Our newest term pop, Dave, is advertising and merchandising in those divisions where we have capacity today.

The next part will be the on set of capacity as it comes on stream middle of this year, late this year, that will help lift growth rates.

R&D, we've got a number of new platform product that is we're working on.

I don't think you should expect to see contributions from those for a couple of years.

These things don't all layout smoothly and sync with one another.

I hope I answered some of your question.

Is that helpful?

That's helpful.

Just one last thing -- Pat, what is your exposure to U.S. auto and housing on a rough percentage?

Do you guys have...?

We'll have to get back to you on that, Dave.

I don't have the aggregate.

We tried to work out more of the variance, Dave.

We'll get you back more of an absolute number.

Thanks a lot.

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

Good morning, guys.

Good morning, John.

In optical film I think you actually have a higher share than Corning has in LCD glass, and I don't know if you listened last week, but Corning changed its pricing strategy.

They basically said we're not going to let pricing fall much further this year, and we're going to test our market share and see how strong we are.

Is it fair to say your market share is not as strong in optical films as Corning is glass or why not take the staple strategy and test the price volume equation?

Really we have to remain very competitive in that marketplace, and we have to continue to work with the manufacturers to where they have to be where we need to be, and that's a very important business that we have to continue to get the volume in the right way.

You cannot become, I will call it an arrogant supplier, in that industry, so let's face it, you're constantly facing other design alternatives, so the solution that you have has to remain competitive from an OEM perspective, and our challenge there is of course to how do we keep driving technology, design enhancements and costs so that the fundamentally we can maintain our position.

John, I think one of the things 3M has just done absolutely remarkably well, and if you ever get a chance to talk to the optical systems people directly, they are just an absolute joy to behold.

They're such incredibly creative people that they are just masters at customizing solutions for new emerging issues for these set manufacturers, and it is one of the things which has helped us maintain margins premium to those of other film suppliers.

So actually in some senses, we might argue that we're already doing in the way we approach the business through technology and great customer relations; we're already doing what Corning is now trying to experiment with.

Okay.

They used to say essentially what you're saying, and I think they sorted of said we think our shares -- our position actually is strong enough to push back on the customers.

I guess you're not there.

Yeah, I don't know that we're not there at all.

We're by far the most powerful manufacturer in this particular segment of the industry.

But I think what we want to do is obviously try to keep as much price as we can for ourselves, but also be mindful that we have customer relationships to build, there is rapid advances in volume, sometimes there are substitutes that people can pick and we got to walk a very fine line, an interesting tap dance in this particular industry, and it will be interesting to see how Corning do it, whether they're successful or not, God bless them.

Thank you.

Our next question is from the line of Shannon O'Callaghan with Lehman Brothers.

Good morning, guys.

Good morning, Shannon.

Just while we're on optical, one quick one on that, you know, in terms of the revenue growth in optical and volume and revenue growth, do you have it on a sequential basis on optical?

It was about flat sequential.

That's units or revenues?

From revenues, so they would be up slightly, you know, volume would be favorable, and then we had a little more -- we would have a price change again in October.

Revenue numbers were about flat.

Okay.

Then, you know, in terms of the comment about, you know, substitutes, are there any new developments to report on in terms of competitive landscape, either on [beth] or [de-beth]?

Nothing from our side.

Okay.

Then in terms of the growth in the margin outlook next year compared to where we were in this quarter, I mean the organic growth was, you know, if you look at volume and price was sort of a little below 4 going to I guess maybe 4.5 to 8.5 or something like that next year, and the margins were down 110 basis points this quarter, and you're looking for, you know, down less than that next year, if you just think about the businesses, which ones do you expect better growth and less margin compression than you saw in the fourth quarter?

Well, it is I guess I have to be careful how I answer this because it will be different throughout the year as we work our way through these.

As George indicated that especially as you got to the top line discussion there, Q1 will be our most difficult period from a comp standpoint because Q1 last year was so hot from the economy standpoint in the LCD market was, you know, running so well, but all in all as we have already talked about healthcare, you have to be a little careful because taking pharma out will impact their margin situation, so you have to be a little cautious on the healthcare business.

But if you look at, all in all, we expect all of our businesses to continue to -- if you lock at our total margin of course we're saying it is pretty well flat year-on-year, it is going to be up slightly from the fourth quarter, so I don't think from a business to business standpoint we don't have anything, any significant trends one-way or the other in the businesses that are probably worthwhile noting.

Okay.

Last one for me.

Can you talk about the capacity utilization in roofing granules, maybe you mentioned that and I missed it?

Where was it, you were bumping up against things, and where is it now and where do you expect it to go?

Yeah.

At times if you go back to early in '06, if you think of a seven-day schedule, we're running better than six days a week and in many cases we're running seven in some of our quarries.

In the fourth quarter, we were down to in some cases three-day operations on average, and some plants were, you know, completely down altogether.

Now, as it comes back and as George mentioned, Q1 is probably going to be the most difficult period for that business, so they will come back on a slower schedule, and then as the year progresses hopefully we'll get back up to more of a normal 5-plus day schedule by the end of the year.

Okay.

All right.

Thanks a lot, guys.

Our next question comes from the line of Jeffrey Sprague with Citigroup.

Thanks.

My main questions around CapEx, but just a real quick clarification on display and graphics if we could.

I think, and John answered this question and he was kind of guessing revenues down slightly and then there was no response to that and Jack Kelly said single digits and there was no sign attached to that number.

Can you just confirm if revenues in LCD films are up and down or what percent?

Are you talking year-over-year, Jeff?

Year-over-year.

Film revenue is up in a single digit number for the fourth quarter year-over-year.

The question is really around CapEx, George, and it kind of goes to this debottlenecking and kind of growth push.

It looks like you spent 5% of sales on CapEx this year.

It's averaged 4.5 the last five years.

That doesn't really look especially low to me.

I mean my group averages 3, 3.5. 3M is a little bit different company, but I guess my question is we have a very steep-looking CapEx ramp here to conceptually debottleneck some growth, but it looks like you got plenty of capital in place, and if there is supply chain issues, isn't that something you can get at more quickly to kind of avoid some of these big CapEx numbers we're talking about?

Jeff, the only way you're going to get those -- if you need capacity and you need capacity fairly broadly, there aren't very many ways you can solve that problem.

One is using productivity measures, extending shifts, trying to do faster line rates, and those sorts of things that will get you a little bit more, but you can be well assured the vast majority of that has been done in 3M.

That low-hanging fruit was squeezed over the last few years.

In the case of the optical business, it is a -- has a different capital profile than past maybe the businesses you're used to.

A new film line comes in assuming you're going to bill it in an existing facility, comes in $150 million chunks, and so you get big pieces of CapEx, and also by the way, Jeff, as we're starting respond to demand in Asia overseas, when you're building entirely new plants, this is an expensive proposition, so I don't necessarily agree with you when you think we have a lot of capacity on the ground.

I think one of the things maybe we need to improve a great deal in is finding way says to do some of the things we've historically done one-way and do them a lot less expensively, or not build plants that will last 100 years but plants that will last maybe 30.

I think there are ways for us to use our capital more efficiently in these businesses, Jeff, but let me tell you that the well was pretty dry, the well was pretty dry when I first came here on capital.

Jeff, can I maybe just add two additional elements because obviously trying to compare against a bucket of competitors a little bit difficult.

One thing that people probably don't understand that well is -- we have a fair amount of I will call it internal chemical manufacturing in our business where we basically manufacture chemicals that are used throughout the Company which is a pretty capital intensive business.

There's other elements of our CapEx going forward, that we're trying to get after how to improve cost in things like optical film and so forth.

You may not get any more revenue per se, but it's really to try to get out a lot more cost, cost effective.

As far as a lot of the import materials into the film.

To some degree, we'll also try to get at the cost side of the equation as well as growth.

That helps.

And just one quick one from me -- on the acquisition, cumulatively, what you did in '06, is there kind of a baked-in accretion estimate that's part of your '07 guidance?

What should we expect there.

Well, I guess it's best to say it's embedded in the number, but as I think everyone realizes that the acquisitions normally will not be at our average.

So when you actually look at the margin numbers that we have given, that comprehends that our acquisitions are muting that down to some degree.

I think that as we looked at our '06 number here, it doesn't help you much for '07, we probably have 30-40 basis points of impact, and that's more of a gross margin line, as I think about it.

That does stir up to a few pennies here or there of EPS.

It does, yes.

Thank you.

That concludes the question and answer portion of our conference.

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

Well thank you very much everyone.

Again, thanks for joining us this morning, and we look forward to delivering a swell and strong 2007.

So cheers, everybody, thank you.

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

You may all disconnect and thank you for participating.