3M (MMM) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M third quarter 2007 earnings conference call.

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

Afterwards you will be invited to participate in the question-and-answer session.

(OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded, Friday, October 19th, 2007.

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

Good morning.

This is Matt Ginter, head of Investor Relations for 3M.

Welcome all investors and analysts to our third quarter business review.

And let me also say it was good to see many of you at our meeting in St.

Paul last week.

I have a few announcements before we begin today's meeting.

As in prior quarters, we'll be doing a Power Point presentation today.

The slides are posted on our web site, at the moment, at 3M.com so you can pull them up there.

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

During the call today 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 forms 10-K and 10-Q list some of the most important risk factors that could cause actual results to differ from our predictions.

On our call today, we have George Buckley, our CEO and Pat Campbell, our CFO.

Both will make some formal comments and we'll get to your questions.

There are a number of other companies reporting today and we all know how busy you are during the earnings season, so we'll keep the call today to one hour.

We'll try to move swiftly.

We'll answer as many questions as we can.

If you could please limit to one question and one follow-up, we'll do that.

And if you have a follow-up question beyond that, get back in the queue and we'll do everything in our power to get to you.

If not, we will be around all day to answer any follow-up questions, that is Bruce and I.

So why don't you please now go to slide number 3 and I would like to turn the program over to George.

Thank you, very much, Matt.

Good morning, everybody.

First of all, I want to thank many of you who were able to join us at our meeting in St.

Paul last week.

I very much appreciate your participation and your interest in this great company.

I know that the time commitment you gave to us was significant and we are very grateful for that.

From my point of view, we had two very productive days and I hope that you now have a better idea of why we are so optimistic about 3M's long-term future.

We will obviously avoid repeating here what we told you just a few days ago.

From your point of view, I hope that we helped to remove some of the mystery about our company and provided some insight into our approach for operational excellence and discipline into our commitment to invest in technology and innovation and new products and how the underlying strength of our broad and diverse portfolio carries us forward.

The access that we provided also to our scientists and to our engineers, to our manufacturing people, to our various parts specialists and to management also, should have been very helpful.

So let's now turn to the third quarter.

This was clearly another good quarter for 3M.

Obviously not everything went perfectly.

It never does.

But given some tough end markets in the U.S., many things did.

The strength of our portfolio was evident again in the their quarter results.

All of our businesses posted positive worldwide local currency sales growth on our way to a record third quarter sales of $6.2 billion.

I would have preferred growth a little bit above 9.4%, absence sales loss from divestitures which we saw in the third quarter, but we clearly moved in the right direction.

It was overall a strong quarter and especially strong in healthcare, which grew at 20.6%, Europe and Latin America also exhibited similar strength with both regions posting double digit sales growth.

I'm also pleased with our EPS growth of more than 10%, especially in the context of the extra investments that we have been making in R&D, supply chain and in advancing our brands.

We show that we are indeed able to maintain premium margins, while accelerating our investments, giving us additional confidence that our longer term plan is on track.

To stay on track, it's important that we continue those investments in growth, especially internationally.

If these numbers -- in these numbers we observed a total of $35 million of commodity inflation in the quarter.

So, as we reminded you last week, we continue to work our long-term growth plan while getting the job done in the short term also.

We know well enough that eggs today are sometimes better than chickens tomorrow.

Having said that, investment in R&D is tracking to end the year at an increase of 10% more than it was last year.

We're also working hard to drive international growth through brand building, and making use of local and regional brands where they make sense.

This also seems to be working well.

Our supply chain is being strengthened and streamlined.

We are investing 35% more in CapEx than last year and so far have brought on stream this year, five new plants outside of the United States.

We also announced two further acquisitions in the month of September.

This makes 15 acquisitions year-to-date.

And I wouldn't be surprised if we announced a few more before the year is out.

So all in all, a strong third quarter.

We continue to work our plan and we are as confident as ever in our long-term future.

In our investor meeting we highlighted the 3M success over the long term, as defined by our ability to apply on going innovation to build what we call enduring franchises.

Franchises like Scotch Tape, Post-It notes, (inaudible) and Scotch-Brite brand reflective sheeting.

We also explained that we are working hard to extend that concept of an enduring franchise into our optical film business.

Similar to the other examples, we invented the basic technology.

As the market changed, we historically moved to serve all market segments from the bottom to the top of the market.

So today we are also doing that same thing in optical.

We don't foresee any technological substitution of LCD TVs, in particular, in high volume for many years to come.

So this is a great long-term market.

But it is essential that we better serve all the segments, including the faster growing but more turbulent lower levels, where, for a while, we can expect further pricing and margin pressure all the time.

For now, this is the area of highest growth as customers seek out perceived higher value.

I want to reinforce what I told you last week.

It's our full intention to protect and build that optical franchise in order to extend and strengthen our position over the long term, to apply our technology, our market knowledge, and our manufacturing prowess in the same way that we built the enduring platforms I mentioned earlier.

So thanks for your attention.

I will now turn the call over to Pat for more in-depth discussion of our results.

Thank you, George and, good morning, everyone.

As George indicated, this quarter we demonstrated the strength of our portfolio from both a business and geographic perspective.

For the second consecutive quarter, we had sales grade of $6 billion.

We maintained strong operational discipline, while at the same time continued to invest in the business to drive long-term sustainable shareholder value.

All consistent with the themes we talked about in last week's investor meeting.

As explained in our press release this morning, and shown on our slide number 5, third quarter reported earnings per share were $1.32.

Included in this result are two special items, which I would like to explain in some detail for you.

First, we made the strategic decision to consolidate our global flexible circuits manufacturing operations from two plants, one in Columbia, Missouri, the other in Singapore, into our Singapore plant to better serve our customers who are primarily in Asia.

Second, as I mentioned earlier in the investor meeting last week, we expect to have a handful of real estate sales over the next several quarters as we actively manage our real estate portfolio.

During the third quarter we sold our current lab facility located in Suwan, Korea which happened to be located on a very valuable piece of property.

Again, we are currently building a new state-of-the-art customer oriented R&D facility closer to Seoul in many of our major customers for only 40% of what we sold the property for.

After adjusting for these two items, earnings for the third quarter were $1.29 per share.

Please refer to today's press release for a more detailed discussion of these special items.

As we discussed in last quarter's earnings call, generally accepted accounting principles prevent us from classifying the divested pharmaceutical business as a discontinued operation.

Therefore, it created a year-on-year comparability issue.

Q3 2006 revenues for the pharmaceutical business were 201 million and operating income excluding special items was 73 million, or $0.07 per share.

Adjusting for pharma and special items, earnings per share increased 17.3%, year-on-year.

On slide number 6, we compare our third quarter P&L versus last year's third quarter.

As you can see on this slide, our results this quarter are very much in line with our overall goals of accelerating top line growth, maintaining our strong operating margin position, while at the same time investing in growth for the future to drive long-term shareholder value.

Excluding special items, earnings per share were $1.29.

A year-on-year increase of 10.3%, and sales growth of 5.5%.

Adjusting for divestitures, mainly pharma, earnings increased 17.3% of sales growth of 9.4%.

Operating income was up 3.3%, to 1.4 billion, or up 9.3%, excluding divestitures.

Gross margin and operating income margin were 47.8%, and 22.6% respectively.

We're in line with last year's third quarter after adjusting for the impact of divestitures.

R&D and related expenditures were up 10% year-over-year, excluding divestitures to support our overall strategy to reinvigorate our business core.

SG&A expense was up 3.8% year-on-year at 1.2 billion, or up over 9% adjusted for divestitures as we stepped up investments in sales and marketing, including an increase in advertising and merchandising to drive growth in many of our businesses.

Our third quarter tax rate was 30.8%, down 1.9 percentage points versus last year.

The lower tax rate in the quarter was principally due to a one time cumulative impact of tax rate changes for several of our European subsidiaries.

We now expect our full-year tax rate to be in the range of 32 to 32.5%, as a result of this quarter's lower tax rate.

Please turn to slide 7 for a recap of our third quarter top line performance.

Worldwide sales and local currency increased 6.3% with 8% from our international operations, and 3.6% from the U.S.

Organic volume worldwide was 4.2%, led by 7.1% increase in international.

Internationally, Europe turned into another very strong quarter, led by safety, security and protection, healthcare, and consumer office business with local currency growth up 11.8%, 8.1% of that was organic.

Rounding out international, Latin America and Canada and Asia Pacific regions saw local currency growth at 11 and 4.1% respectively.

Organic volume growth in the U.S.

was up slightly with strong growth in Health Care, and Electro and Communications was offset by weaknesses in the hand held businesses that are impacted by the slowdown in the U.S.

housing, road construction, and mass retail markets, namely our [industrial] minerals, protected materials, traffic safety and office supply businesses.

Worldwide, acquisitions contributed 2.1%, while prices were flat versus last year's third quarter.

Divestitures, primarily pharma decreased sales by 3.9% and currency translation added 3.1%.

Before we move to the business segment highlights, please refer to slide 8, where I would like to comment on our year-to-date performance.

Excluding divestitures, mainly pharma, sales were up 10.4%, year-to-date with operating income up 12.5% and earnings per share up over 17%.

Capital efficiency is equally important to growth and margins.

Our return on capital was 22.2%, up 40 basis points from last year's comparable period, adjusted for divestitures, mainly pharma.

As you can see, through nine months, we continue to execute against our plan of accelerating growth, maintaining margins, and investment returns while delivering double digit earnings growth.

Overall, our plan continues to remain on track.

Now, please turn to slide 9 where I will review our quarterly and year-to-date results by business segment, starting with industrial and transportation.

Driven by broad based growth across the portfolio, our Industrial and Transportation business delivered another great quarter with sales growth of 9.3% and operating income growth of 11.4%.

Sales growth was led by our industrial adhesives and tapes business, followed by automotive OEM, automotive buyer shops solutions and abrasives businesses.

Organic local currency sales increased by 4.2% with an additional 1.2% of growth coming from acquisitions.

Year-to-date, sales were up 8.2%, with operating income growth of 10.7% as the business continues to drive strong productivity programs, with operating margins of 50 basis points year-on-year to 21.3%, a record margin for this business.

Some of the products driving growth in the third quarter were specialty chemicals for the oil and gas markets, paint preparation systems that delivered productivity in paint boost for body shops, laminating adhesives, providing attachment solutions in industrial applications and packaging tapes, just to name a few.

Strong market penetration in emerging markets, particularly the [brick pea] countries, continued in the third quarter.

Europe, Middle East, Africa, as well as Latin American regions all showed its strong local currency growth.

The Industrial and Transportation business continues to invest in R&D, to strengthen its core technologies, while adding strategic, complimentary acquisitions to boost our core adhesives, tapes and abrasives platforms and to expand into adjacent markets.

We've recently announced the acquisition of Venture Tape Corporation, a global provider of pressure-sensitive adhesive tapes based in Rockland, Massachusetts.

Venture Tape manufacturers a broad range of tapes using construction, oil and gas, HVAC, electronics, aerospace, marine and appliance markets.

This acquisition broadens our pressure-sensitive adhesive tape platform, bringing new challenge to 3M and allows us to expand into adjacent markets such as the global construction market.

Please turn to slide 10 for a review of third quarter results for our Display and Graphics segment.

For the quarter, Display and Graphic sales were up 2% or over $1 billion, a record quarter.

Sales growth was negatively impacted by over 2% due to the divestiture of the Opticom & Canoga loop business along with product rationalization in a couple of our other businesses.

Local currency growth was 1%.

Year-to-date, Display and Graphic sales have increased more than 4%, with profits up nearly 6%.

Our market leading Optical Systems business continues to focus on market segmentation with strong penetration in handhelds, computer displays and LCD televisions.

We did experience attachment rate loss in LCD desk stop monitors and LCD TV segments in Q3 as competition continues to intensify in this market.

We also noted a slowing in the mix from 720p to 1080p LCD TVs, which impacts our business as 3M films are used in more heavily in 1080p sets.

As the market leader, we will continue to compete aggressively, balancing product innovations, price, and volumes across the entire brightness enhancement film product pyramid.

This meets continued price down to meet our customers class down requirements.

Our continued commitment to invest in this business has led to a solid stream of new products that our customers are very excited about that will allow to us continue to maintain our market leadership in brightness enhancement films.

3Ms brightness enhancement films provides an environmental solution to reduce energy consumption, a rapidly increasing requirement from retail customers and government units.

We also are on schedule in scaling up and improving the productivity of our manufacturing facilities.

Commercial graphics posted another solid quarter with strong sales growth.

We saw an uplift in the vehicle wrapping market, where we provide films, [things] and other products for this rolling billboard industry.

Likewise, in traffic safety systems, they posted continual seasonal growth internationally driven largely by the road construction season.

The U.S.

highway construction market were slowed in the third quarter, sequentially from the first half of the year as the industry is facing substantial material inflation for cement and asphalt, which is driving more of their spend into construction materials for rad servicing versus other spends such as sign sheeting.

Please turn to slide 11, where we'll discuss the third quarter highlights for our Health Care business.

Once again, health care had a great quarter with broad-based double digit growth across all divisions, excluding pharma.

Local currency growth including acquisitions was 16.6%, with 4.6% coming from acquisitions.

Of the remaining organic growth, 4.5% resulted from the recent supply agreements related to the sale of our branded pharmaceutical business, in which our drug delivery systems business became a supplier to the acquiring companies.

Of the 4.6% of growth from acquisitions, much of the it came from two deals.

BioTrace International PLC, a UK-based provider of microbiology products and SoftMed, a Maryland-based provider of health information software solutions.

We also acquired Neoplast, a Bangkok based manufacturer and distributor of consumer and professional skin and wound care products.

Excluding pharma, sales in health care were up 20.6% over the third quarter of 2006 and profits were up 13.7% ex-pharma, to $259 million.

Year-to-date margins were up 27.7%, overall sales were up 22.7% year-to-date and operating income was up 19.1%, both excluding the sale of pharma.

Within the segment, each business delivered double digit sales growth.

Our drug delivery systems business, where we leverage multiple 3M technologies, global regulatory expertise and manufacturing precision led the way.

We also saw strong sales in health information systems where we are the worldwide expert in healthcare funding and performance management solutions.

In dentistry, we continue to deliver a steady stream of new products and have been voted the most innovative dental company two years running.

In fact, we just recently launched a new product in dental which is new to the world technology that creates the lower shrinking composite filling material available, along with two state-of-the-art adhesives for better bonding and patient comfort.

In orthodontics, our self-ligating brackets are the fastest growing segment in the market, 3M's exclusive Smart Clip braces system is leading the way, and we saw impressive double digit growth in their business again this quarter.

Please turn to slide 12 for details on our Consumer and Office business.

Consumer and office sales increased 5.9% to $898 million in the third quarter.

Local currency sales were up 3.5%, including 1.1% from acquisitions, primarily due to the October 2006 acquisition of Nylonge, a global provider of household cleaning products, including cellulose sponges.

Profits were 192 million with operating income margins of 21.3%.

The consumer and office business is having an outstanding year with year-to-date sales up almost 8% and operating profits up 12%.

Year-to-date growth has been led by the consumer mass retail and the do-it-yourself retail channels.

Strong growth in home care came from Scotch-Brite scouring products.

In construction and home improvement, growth came from Filtrete air filtration for the U.S.

residential HVAC systems, along with command mounting and fastening products in the their quarter.

As previously mentioned, sales growth was tempered by weakness in the protective materials and the office mass retail channel in the U.S.

Geographically, 3M's international subsidiaries contributed drive growth again this quarter, with double digit growth in all regions led by Europe.

During the quarter, we stepped up investment in advertising and merchandising to drive growth in the back-to-school season.

We will continue to invest in advertising during the fourth quarter to accelerate growth during the holiday season.

Please turn to slide 13 for a recap of our third quarter performance by Safety, Security and Protection services.

Led by growth in respiratory protection, corrosion protection and building and commercial services, we delivered sales growth of nearly 11%.

Third quarter growth in local currency was 6.7%.

Overall segment year-on-year sales growth was held back by almost 2%, due to our industrial millage business for supplies and minerals used on asphalt shingles for the U.S.

residential housing market.

As you are aware, housing in the U.S.

remains very sluggish and our U.S.

investment minerals business is really a U.S.

centric business.

Geographically, sales growth was led by strong double digit growth in Europe, followed by Latin America and Asia Pacific.

For those of you that attended our investor meeting last week, you got the opportunity to see the products and technologies of Rochford Thompson Equipment Limited, a recent acquisition by our security business.

Rochford Thompson is a manufacturer of optical character recognition password readers used by airlines and immigration authorities, headquartered in Newbury UK.

The addition of Rochford Thompson enhances 3Ms secure document scanning solutions portfolio, and allows expansion into the transportation markets, such as international airlines.

Operating income increased almost 11% as the business continued to maintain consistent operating margins in excess of 20%.

Year-to-date sales have increased 16.6%, with profits up 15.7%.

Please turn to slide 14 to review the third quarter results for our final segment, Electro and Communications.

The growth results in this business continue to be mixed, however, the financial results continue at record levels.

We continue to experience strong growth in electrical markets and communications markets, which have been somewhat offset by declining growth in some of the products we supply in the consumer electronics market, which are end devices that have come to end of life, adversely impacting sales in our electronics solutions division.

In the electronics markets material division, started to see some recovery in the third quarter in consumer electronic applications, fueled by demand for fluids.

Overall, the electro and communications business has taken the necessary corrective actions to respond to the slowing consumer electronics market.

As mentioned earlier, the electronics solutions division announced a consolidation of manufacturing operations and reductions in structure to allow the business to strengthen to a competitive position.

At the same time, our electrical markets and communications businesses delivered strong double digit bottom line growth, offsetting the weakness we saw in the consumer electronics piece.

Sales were up 7.6% over the third quarter last year with local currency growth of 4.3%, including [110] basis points of growth from acquisitions.

Strong results continue in Europe and in the U.S.

for communication and electrical markets.

Outstanding cost discipline continues to generate profits that increased 16.4% over the same period last year with margins up 1.5 percentage points to 19.6%.

Year-to-date sales reflect a slower first half, with an increase of 4.9% and profits increased 13.5%, versus the first 9 months of 2006.

Please turn to slide 15 where I will review a few balance sheet and cash flow metrics.

Excluding tax -- tax payments related to the gain on sale for the branded pharmaceutical business, free cash flow in the quarter was $693 million.

This year-over-year cash flow drop is more than accounted for by higher tax payments.

Third quarter free cash flow includes a $200 million U.S.

pension contribution, which is the primary driver for the lower free cash flow from Q2.

Both year-on-year and sequential working capital turns up stabilized at 5 turns.

Capital expenditures totaled 379 million, an increase of 67 million year-on-year and 31 million sequentially.

Year-to-date we have invested greater than $1 billion in capital expenditures on track with our full-year expectation of 1.4 to 1.5 billion.

Dividend payments to our shareholders were 343 million and we continue to buy back stock during the quarter, albeit at a slower pace than previous quarters, with gross share repurchases of $557 million.

Weighted average diluted shares outstanding of 729.9 were down 3.5% year-on-year and down slightly sequentially.

And finally, our debt-to-cap ratio is 32.3% at the end of the third quarter.

This concludes my formal business review.

Now I would like to turn the call back over to George for his closing comments.

George?

Thank you very much, Pat.

So let's speak now about the rest of the year.

To set the scene, the third quarter was characterized by some ups and downs, as there always are.

For example, we saw good results in oil and gas, mineral extraction and aerospace.

We also saw surprisingly strong results in industrial tapes and adhesives, abrasives and most of our global automotive business.

We also saw some late quarter rejuvenation in our electronics business, as Pat mentioned, (inaudible) selling bonding ceiling materials into the electronics industry as it finally seems to have come out of the deep sleep that we have seen most of the year.

Our construction and home improvement business also did very well, posting 7.5% sales growth as we continue to win share and launch new products.

Our investments in R&D and in acquisitions are clearly paying dividends in all of these areas.

On the other side of the equation, it will be no surprise to anyone that we saw continued softness in the roofing granules business, which continues to drift down slowly in sales.

We do not expect to see sales growth improvement in this business any time soon, even though it has performed relatively well from an earnings standpoint.

The growth and optical films for LCD TVs is currently slower at the top of the market where our position is strongest.

Consumers are driving the lower reaches of market fastest right now.

And as we mentioned in our investment meeting, we have new products coming in Q4 and Q1 to grow our offerings as we invest and defend and advance our leadership position in that market.

As a practical matter, defending our position here will cost us some price in Q4.

But the long-term effect will be to extend our optical franchise, which remains a very good business of 3M today and well into the future.

While consumer markets did moderately well in the quarter, with overall growth of 5.9%, we do see signs that replenishment orders, mostly for use in offices, are slowing.

This is all a U.S.-based anomaly and international markets remain robust as Pat outlined.

So for the balance of the year, we expect to see the pattern of absolute growth remaining at levels similar to what we have seen in Q3.

The business environment in the U.S.

market remains the biggest immediate challenge as we go forward, however, we remain committed to our 2x IPI goal.

And while the better of our portfolio helped us enormously, I think we all know that can't fully insulate us from economic effects.

However, whatever economic share we might -- scenario we might encounter in the U.S.

going forward we retain the resolve and the means to find market share, continued growth and profitability.

That's what we will be doing.

So with respect to earnings, we expect to finish the full year between $5.54 and $5.62, up from last quarter's expectation of $5.40 to $5.60.

These earnings include $0.68 to $0.65 in one-time gains from special items.

All in all, despite some end market challenges, we expect to finish the year 2007 as a wonderful year for 3M.

Having done a great deal of fixing and rebuilding to accelerate growth while maintaining our outstanding returns.

We completely overcame the impact of sales lost in the sold pharmaceutical business and I think it's testimony to the resilience of 3M and it's people that we've seem to have done so with ease.

So, congratulations to all of them.

With that, I'd like to turn the call for any questions that you might now have.

Thanks a lot, everybody.

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

Your first question will come from the line of Mike Judd with Greenwich Consultants.

Please go ahead with your question.

Yes, good morning.

I have a question on the display and graphics area.

I just wonder if you could flesh out a little bit more information, the issues around the -- the mix shift, from 720p to 1080p?

And also your comments about pricing and margins.

I guess I would infer from that that you are basically lowering your price, as is typical in the electronics area.

Yes, Mike.

Thanks for the question.

What really started this was the plasma guys were getting a little nervous about their seeming inability to penetrate the market.

So they lowered their prices first.

The LCD guys in a similar, sort of, display area then followed suit.

And, of course, it left the 1080 guys in a position to sit where the prices were or follow suit yet further still.

So what tended to happen is, growth then was stirred in the lower end of the market place and that's sort of seen the rise of companies like [Viseo], you might have seen the data where they essentially went from nowhere to number one position in about nine months.

So, a lot of dynamics going on in this marketplace.

But in reality, what will happen longer term is, I think the -- obviously the upper end of the market, like, is going to respond, and so the big growth is occurring in the 720 area of the marketplace.

We have few products in that area, and in order to unfold our concept of this optical enduring franchise that we have so many other places, we see a need to service that part of the market just as we service the top, and so what it will mean is that we will be releasing products in the fourth quarter and the first quarter, and the practical reality is that those products are lower margins, but I want to stress we don't see this thing going into any serious trouble.

We still think that long term the optical film business is going to have a margin comparable to or perhaps even higher than the Company average.

So we are -- we are relaxed at doing this.

It will cause, I'm sure, some turbulence and some concerns here and there, but we're very relaxed with this as a move in the market.

Just as a follow-up to, that if you were to think about next year in terms of revenues in that business, and you were kind of running through volume versus price versus mix how would those numbers sort of -- how would that work?

Well, I suspect that you are going to see some continued pressure.

When you mix it all together, what's going to happen, Mike, we're obviously going to see some significant volume pickup in the bottom of the market, but the margins there are less attractive than they are clearly at the top of the market.

And the benefit that we get is we have all capital in the ground.

We have the technology.

This is nothing new to 3M.

It's in our absolute heartline as the kind of things we almost do in our sleep.

And so we some -- some nice absorption lift in that bottom end of the market, but there will be a blended drift down, I think, in the overall margins of that -- of that marketplace.

But the key for us is it makes us far more important to customers.

It makes us able not just able to get the volume gain at the bottom but secure at the top and remain vital in this business to our customers.

Thanks for the help.

Your next question will come from the line of Deane Dray with Goldman Sachs.

Please proceed with your question.

Thank you, good morning.

Good morning, Deane.

Question just to stay on display if we could, could you quantify for us what the dynamics were in the quarter on the pricing decline and volume specifically?

Yes, Deane, the pricing is very consistent with what our historical trend has been, and has basically been offset by volume, but if you look at that business, it's basically flat, kind of on a year-on-year basis from a revenue perspective.

How about volume?

Volume would have been basically offsetting price.

So revenue would be about flat on a year-on-year basis.

Okay.

And then, George, just maybe -- maybe it's premature to quantify what the impact will be as you go down market on this, and it was very clear last week at the analysts meeting why you are pursuing this from a strategic franchise standpoint, but when you say that the margin, it may be gumming down to the company average or just above the company average, that could be pretty significant.

And what time frame are you expecting this impact?

I think Deane, this is probably a multi year impact.

Obviously, the volumes in these, as we release these products, Deane, it takes a little while for adoption to take place so that may take one, two, quarters or so.

But I think this is the kind of thing that will probably unfold in the next 18 months.

Probably will get ease, as we get closer to the transition, Deane, for the high def televisions, probably easing at that time would be my guess.

But building volume and building market significance for 3M.

So we maintain that influence in the marketplace, and it's a very important marketplace.

So I think this is not some precipitous thing that's going to happen next quarter, but I do think it's something that we will see transitioning go over the next year and a half.

Deane, could I bring you back a little bit to maybe a couple of pieces of my presentation that I had, where we talked about the overall margins of the Company.

What we're telling you about LCD, it's very consistent, okay, that we can manage the LCD business within the construct, okay, of the overall company margins.

We have been anticipating that margins in that business will have to come down, and as we showed you, that the margins in the other piece of business will continue to rise.

So on a mixed basis, at a company level, I would not get too excited about it.

(multiple speakers) a lot of growth.

Thank you for the color.

Your next question will come from the line of John Roberts with the Buckingham Research.

Please proceed with your question.

Good morning.

Good morning, John.

Your comments on the consumer electronics industry in the electro communications segment, is that cell phones primarily or are there other consumer electronics there?

The most significant issue we have is an application -- well, I guess a couple of things.

One is the application in ink jet printers which I think you are well aware that that business continues to erode, and we had a very large business site there.

And, of course, that's just going to eventually end the life of volumes coming down significantly.

We did have a few other applications in some cell phone applications.

That, of course, has changed the design as well.

So both areas.

Okay.

And then the cell phone weakness has not affected the optical films business at all?

No.

Not at all.

We are still very strong there.

Thank you.

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

Please proceed with your question.

And good morning.

Good morning, David.

George and Pat, going back to optical films, ignoring the margin for a second, what does the new strategy imply for operating profit growth over the next two years as you increase the volume in sales dollars?

Can we see a scenario where margins are down but operating profit growth is maintained at a fairly high rate?

I will try to tackle that.

Dave, it's a great question, and, of course, something that we are looking at customer by customer, application by application.

As George described in his presentation, what we want to do is make sure that we maintain the leadership position in enhancement films across the entire segment.

So obviously we are trying to go after volume.

I will, at this point in time, not necessarily guarantee you that profitability will actually increase in the near term.

But, again, I want to bring it back to the context of the Company as a whole.

The broad portfolio we have drives the -- the double digit growth that we have talked to you in the past about.

So it has been part of our plan, and we are going to execute to that.

But I would not necessarily see us in the near term necessarily that we see the profit increase in that business.

So just to be clear, could we expect optical films profits be flat in '08 versus '07?

Too soon to give you that forecast, Dave.

And last thing, any sign of slowing in Europe?

Not really.

Our European -- yes, I probably seen the same pieces of data that a lot of you have seen relative to some macro economic indications that there may be a crack or two in the system but we have not seen it in our business thus far.

In fact, David, what we have been seeing in some places where we have been traditionally slow, consumer office, where the growth wasn't so good, we have seen advancing growth in those areas.

So we seem to be doing some things which are offsetting some of the -- there are tendencies along the lines that you are speaking about, we seem to be getting better penetration in some markets that's offsetting that.

Thank you.

Your next question will come from the line of Stephen Tusa with JPMorgan.

Please proceed with your question.

Hi, good morning.

Good morning.

Kind of a nitpicky question.

What exactly happened in interest and other income?

I think it was like $50 million, and that's up pretty substantially year-over-year but also up from the second quarter.

Well, primarily because our debt levels are up pretty significantly.

Obviously, borrowing rates are up from last year.

I mean, that's the simple answer.

I think that's a -- it's a positive, though?

It's a positive $50 million, it's not an expense.

I'm sorry, are you talking income or -- I'm, sorry, expense or--

It's interest and other income.

It is the line item and it's up, it's $53 million, versus 13 last year and --

I'm sorry, you are talking the income piece of it?

Yes, yes, yes, absolutely.

Absolutely.

Sorry for not clarifying.

I'm sorry.

I was thinking of the net.

Okay.

Sorry.

No problem.

Our cash balances are up.

Some of the returns that we are getting, okay, are favorable on that side.

Obviously try to look at the net, the net impact of the cash and the debt side of it, but it's a combination of the two.

Our cash balances are up, primarily outside of the U.S.

and some of the returns, obviously we get in the market place are a lot better than they were last year.

Steve, this is Matt.

Maybe we could follow up afterwards if there's any confusion.

But quarterly interest expense was 53 versus 37 last year.

Okay.

So it is up.

That's up and interest expense was higher than last year as well as the cash balance is up as well, so.

Right.

The other question is, George or maybe Pat, could you just maybe give us when you look out here, other than display and graphics, what worries you the most?

What are kind of the key variables?

And '08 would be great, but if you don't want to get into '08, maybe what are the key variables for '07 for the rest of '07 for the fourth quarter to hit your guidance?

What are going to be watching over the fourth quarter outside of display and graphics?

I think it's much of what we said already, Steve.

The consumer office business, it's [tied] for in the U.S., there's no question about it, they did well, the numbers show that they did well, offset by great growth internationally.

So I -- I think their numbers will -- will go sideways.

They will do just fine.

In the -- the thing that we saw, the -- last year, Steve, was in the -- in the industrial markets, in particular, distribution, we saw a lot of slowdown towards the end of December, and so we have got to make sure that we watch that and we are working very, very hard to make sure in the early parts of quarter here that we don't get caught by that surprise at the end of the quarter.

So that's an issue.

Because when you -- you are feeding into distributors, clearly they have a lot more choice on whether to take or not to take.

So that -- that's something that we at least want to make sure that we don't get trapped by as we did last year.

And then it's some of the old faithfuls.

It's probably the -- the roofing granules business, but -- I mean, I don't expect any big change in that from the third quarter.

So it's -- it's -- Steve, it's a bit of consumer, watching the industrial thing and if you saw the industrial growth rate, they were great, but just going to make sure that we continue those right through the quarter, we don't get tripped at the end as people sort of go off on vacation and that's probably most of it.

And then one quick one.

When we look at all the capacity that's coming online in the third and the fourth quarter, at least it's going to starting up here, what gives you the confidence that the roofing granules business remains pretty weak.

And you guys kind of added capacity there into the teeth of a downturn.

I mean, what gives you confidence that you are actually building to demand here?

And how concerned should we be with regards to that as we look forward to '08, given that you are spending so much money in the next -- in the their and the fourth quarter to get these plants up and running?

Well, there's a couple of questions in there.

In the roofing granules business, Steve, we took out one plant in the northeast, which eases some of the overcapacity.

And by the way, we were supplying markets well into the south from that plant that really sort of hurt us in cost in that business last year.

So that's -- that's gone away.

In the overall housing market, I don't know if there's any of us out here that would hold a lot of optimism in the immediate future for housing.

On the other hand, you see what's happening now in our consumer and home improvement business.

We are through penetration, through winning new accounts, through -- in some cases, knocking down competition, getting penetration there, and through new products like Filtrete and [Command] and we continue to do that.

It seems to be working okay for now, Steve.

So I'm not -- I'm not negative on that business, but it will require the same -- the execution of the same old 3M formula.

A lot of innovation.

A lot of new products into the channel to make sure that we -- we remain stable in that business.

Okay.

I just want to go to the other capacity that -- all the capacity that's coming online, eight or nine plants that you are adding in the next two quarters, how comfortable that you are not adding this into this global slowdown that many are anticipating?

Well, first of all, the vast majority of the capacity, Steve, is coming on stream overseas.

Yes.

Yes.

And the plants are arranged in such a ways that you build a box, and you only put enough product machinery in those plants that are appropriate to current levels of demand and then you obviously add to them as the demand increases.

So you don't necessarily carry all the burden of an unfilled plant.

But as a practical matter, Steve, the reality is, when you have a plant that takes two years and you have a market that changes in six months, you have no choice but to sometimes build ahead and try to plan in a scalable manner as you add capacity.

And even if there're temporary dips in the U.S.

market or even in some parts of the international market, the reality is those will last six months maybe, and we will be in a position to respond to the growth as it might come back and it will.

So it's impossible, Steve, to time the opening of a plant and the exact addition of the capacity to follow economic circumstances.

It's just -- none of us have those kind of levers and that kind of refinement or finesse to be able to do that.

So, you do consume some of that.

Yes, Steve, let me just add, those -- especially internationally, the plants are being installed in, as you recall, China, India, Poland, Russia, which all have very significant -- the developing part of the economy is just absolutely booming.

So most of the capacity internationally is going into the highest growth parts of the economy still today.

Okay.

Right.

Right.

Thanks a lot.

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

Please go ahead with your question.

Thank you.

Good morning.

Good morning, John.

By the way, sort of interesting Pat, you hit your five-year tax rate target this quarter.

(laughter) Anyway, my question, Pat, actually is on how much did raw materials, particularly given the price of energy, drag this quarter?

And if not this quarter, given the price -- the rising price of oil, or is that going to be a head wind and perhaps a little color around that?

And then the second thing would be just, currency, up 3.1% top line.

What was the translation impact to earnings per share?

Yes, John on the materials side, I think George kind of mentioned commodity number of about 35 million.

Okay.

Impacting the quarter.

That's kind of the -- that's kind of head wind piece.

I'm sorry, what?

Does that get worse just based on what's been happening, Pat?

I mean, who -- who knows, again, whether he's going to play out.

But importantly, we have got a very, very active purchasing group that continues to -- if we see those commodity head winds, in some cases you have to absorb those and you will find other ways of getting offsets.

So they are very much on track of trying to manage our net material cost on a cost down basis.

You can guarantee -- can guarantee that we won't let them off the hook, okay, in a tough commodity world or not.

So it is a factor of business, and I think what is great is even with -- if you go back and look at commodity prices over the last five years, I mean, a lot of these things are double, triple what they had been, and yet our margins have continued to grow.

So I think it shows the overall strength of the Company.

On you point exchange question.

We had probably $0.05 or so benefit here in the quarter, relative to exchange.

And then just on consumer and office.

Consumer and office, George, was sort of a nice profit surprise, given sort of what had been happening in the office retail channels in the U.S.

Based on that outlook, though, is that business going to start to drag, maybe a little color around -- I know you said you thought it could hold together.

But I'm just wondering what's the profitability of it, particularly given, sort of, what you saw with respect to your back-to-school season and just sort of what -- kind of what the trend is there?

I think, John, we -- the mix of the business is going to change.

I see no reason to believe that -- until the U.S.

economy shows a little bit more robust trends that we will see much difference in the way the U.S.

consumer and office business unfolds.

You can kind of separate that into two pieces, John, the office piece seems to be the -- the weaker.

Consumer home improvement, which is in that segment, John, you saw in the numbers did very, very well.

Now the positive news, as I said earlier, was we seem to be getting real traction in consumer and office overseas.

So net/net, I suspect the performance in the fourth quarter is going to be similar to that that we saw in the third quarter.

Of course, we all know, John, I think, because you and I talked about it personally, the -- what we really need is continued to drive innovation, but at the same time, hoping and anticipating that we will see some turn around there sometime next year in the underlying end markets for housing.

But your guess is as good as mine on whether that happens in one quarter or a later quarter.

So all in all, John, I'm not -- I'm not especially worried about some -- some terrible worsening of the consumer market.

We seem to have been fairly [adaptable] in both international markets in innovation continuing to drive that business.

And you are right to observe, we have been doing quite well, relative to some of the penetrations of our consumers -- of our immediate customers.

Hey, John, your question on margins though, be a little cautious.

The third quarter in that business is usually their peak.

Right.

It's their volume peak, it's their margin peak.

So, just don't try to extrapolate that out into the future, because it is kind of a peak period for them.

Nope, I understand.

Thanks very much.

Thanks, John.

Your next question will come from the line of Jeff Sprague with Citigroup.

Please proceed with your question.

Thank you.

Good morning, everyone.

Good morning, Jeff.

Just back to d & g for a question and then maybe a general question, maybe, on margins overall.

But when you think about kind of this press into the low end to kind of defend your turf and drive the growth, do you have share today with these emerging new low-end OEMs like the Visio's and some of these other players or is that kind of virgin territory that you need to try to conquer?

Yes, Jeff, yes, we do.

We do have penetration really in most of the applications.

It is just a -- let's face it, the price cost sensitivity at the low end of the market is more severe.

So that's something that we just have to battle day in and day out, and as George outlined last week, we're going to compete in all aspects of that market.

And I'm just wondering if we think about margins overall and, Pat, the model you laid out last week is kind of understandable, kind of recycling the operating leverage, et cetera, back into the business, but specifically, I'm just wondering which businesses do you think have the most margin upside from here if you are, in fact, going to look at 5, 600 basis points of margins down in display and graphics over the next 18 months or so?

Well, Jeff -- and obviously, this is an ongoing management -- where the opportunity is, where we want to invest and so forth, but I think it's fair to say that really, across the -- across the Company, we have opportunities.

And one of the thing I laid out for you is we still have opportunity as we leverage our growth rate into our fixed cost structure, which really effects all businesses.

So there's -- there's opportunity across all of them.

But, George and I, we have to place bets on where we want to invest and so forth.

We do manage the Company in total.

So, if optical needs a little bit of support because their margins are eroding, obviously we've got to find offsets.

We continue to drive productivity across -- across the organization.

So generally speaking, I would say we really have opportunities in all businesses, but -- so it's a matter of -- if you took that model I talked about, we actually run that model through each one of our businesses as well.

We decide how much you want to apply back into margin versus growth, is something that we just actively manage.

But I would say that underlying all of our businesses have growth potential there.

I just wonder if you could give us a little sense of how to think about cash flow going forward?

There's still some pressure, obviously, a little bit on the working capital turns.

It looks like receivables are up on kind of softer sales.

Is this still -- I guess, first, if you could comment on the receivables given sales growth is a little bit slower.

And then I guess the question of inventory turns kind of goes more to the supply chain issues.

But what we might expect going forward?

Well, see, Jeff, I -- to me, one of the good sides of the quarter, when I look at working capital in total, it looks like we have stabilized the situation.

So as I look on a going forward basis, we -- we should basically be able to improve our performance as we continue to get our supply chain kind of squared around.

On the receivables side -- the thing you have to be very careful of is, you have to see where the sales occurred during the quarter.

If they occurred more back -- towards the back end of the quarter, you end up with, obviously, more receivables on your books at the end of the quarter than you do if you look at it more on an average basis.

We have some receivable follow-up issues that we have to keep -- keep working on as our international piece of business continues to grow faster than the U.S., that actually hurts our mix a little bit because of their turns are lower than what they are in the U.S.

So we're very much focused on that, but if you look at it from a forward-looking cash flow projection, I think our working capital turns now, I feel pretty good that we have stabilized the situation and that should not provide leakage on a going forward basis.

Thank you.

Your next question will come from the line of Shannon O'Callaghan with Lehman Brothers.

Please proceed with your question.

Good morning, guys.

Good morning, Shannon.

Sorry to keep you on optical here.

I'm sure you are sick of hearing about it.

Just one clarification.

When you talk about, you still think it is a business that can have company average margins or better, I mean, was that -- it sounded like that was an optical comment not for the whole segment, I mean, would that imply that the whole segment you would see is lower than the Company average?

No.

No, we were not trying to imply that at all.

Okay.

So, I mean, if -- I mean, if all D & G were at the Company average, obviously optical you'd still think would be better than that?

No, I think that D & G on a mixed basis will not drift too far away from where the Company average would be longer term.

Okay.

And then I guess just if I could understand the growth there.

You took down the growth target for D & G when we were up in St.

Paul, and if you are going down market, shouldn't the volume accelerate?

I mean, I guess the price pressure is obviously much worse.

Can you give us a sense of when you are adjusting whole segment there, is that really driven by optical in terms of the downward revision?

Yes, I would say the -- at least my thought process is that entire revision is really related to optical, and I would say it's probably more so of two aspects.

One is the mix -- the mix of the business.

Because our volume expectations really haven't changed all that much relative to TV projections from an end market perspective.

And then probably our assumption relative to the prices is more aggressive than we previously had.

I think, Shannon, (inaudible) question, that, obviously, there's a lot of dynamics in this marketplace.

What is likely going to happen, I think, in the near term is, we will see, not just in the lower segments but even in the higher segments both the continued margin pressure, the continued pricing pressure, that the challenge for the Company is to kick into absolute high gear, all it's activities on double wide, double speed yield improvements as a means of offsetting that kind of pricing pressure.

Now will we net/net be able to offset that?

I suspect there will be some net negatives that come out of it.

But the beauty is that, as this, sort of, battle unfolds, and we've fought this battle and seen this battle many times in our history, it's likely to go on for the next year and a half, and then there's relief at hand, which is in the change to the high def televisions, which will probably ease some of the pricing pressure, and will probably move the market back up a little bit, it would be my guess, towards the 1080p.

So we'll benefit again from that.

But as this -- and then maybe stability, perhaps, obviously more capacity coming on stream as demand increases but probably relative price stability for some time.

And then this market, by that time, will have captured 60 to 70% of the TV volume in the world, which means it will then probably ease in and evolve into a much, much more stable market for the future.

That would be the way I would read, kind of the ups and downs of this market over the next four or five years.

Matt, do you have any -- do you have an opinion?

No.

So, long term we are genuinely very positive about this market.

It doesn't mean in the short run we won't have some hand-to-hand combat, you always do.

Especial in tougher economic times where people are very sensitive to price.

But all in, all, it seems like a great market and we have the capacity.

We have the technology.

We have the role.

We have the customer contacts.

We have to make this the kind of great business that we have in many other segments of our company.

And just last one for me.

Thanks for that.

Just getting from sort of the growth rate you saw this quarter, you mentioned not everything went right, but in terms of getting, sort of, back into that 5 day percent range and maybe towards the higher end, what are you really looking at to drive that acceleration?

Much of the same stuff we have been doing before.

It's getting our plants opened that are close to new customer demand and getting our fill rates up, that'll lift part of what we're doing.

The new product machine seems to be in top gear right now.

We are spending a lot more money on R&D.

The new product vitality index is going up.

So this stuff is feeding into the market place, and in the end, it's products which are the solution to the problems.

In particular, if you just take a look at a segment that we've talked about quite a lot today, the consumer and home improvement segment, which is really -- was originally kind of a paint and dry wall business.

As we added to the portfolio in that business, with filter products, with more adhesive products, it took the edge of some of the pressure off that we might have seen in the traditional core.

And we'll continue to do that.

It's the plain and simple answer that innovation remains the key.

Okay.

So it is sort of the broad strategy, not a particular segment that's going to do it, it's going to be sort of across the board based on what you are putting in place?

This is happening right across the Company.

We are not abandoning anybody.

But there wasn't anything in this quarter that was particularly soft, you expect the one sort of -- the one that kicks up, it's just sort of the broad strategy coming into effect?

Yes.

It was as we said, there was just continuation of the roofing granules stuff that we've seen now for a year, and the -- the shift within the optical business, and a little bit of U.S.-based consumer.

They were the things that were the driver that so many of the positive things came through.

It's interesting the words that we used on the growth, a company of our size having 9.4% growth in the quarter, is pretty spiffy, nonetheless, no matter what you say.

Okay.

Thanks a lot, guys.

Okay.

Well, thank you very much -- Go ahead.

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 everybody for joining us this morning.

I would just like to reiterate that while we have a lot to do yet, our plan is on track and we are confident in our ability to execute it.

So thank you very much for listening.

We much appreciate it.

Thanks, everyone.

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

You may all disconnect and thank you for participating.