3M (MMM) 2009 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the 3M first quarter 2009 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, APril 24th, 2009.

We would now like to turn the call over to Matt Ginter, Vice President of Investor Relations for 3M.

Thank you, Rachel.

Good morning, everyone.

I'm joined today by George Buckley 3M's Chairman, President and Chief Executive Officer, and Pat Campbell, 3M's Senior Vice President and Chief Financial Officer.

Today's call will summarize 3M's first quarter financial results.

The conference call slide presentation will accompany our comments, which you can access on 3M's Investor Relations website at 3M.com.

The slide presentation will also be archived on our website for an extended period of time, along with a replay of today's audio webcast.

Please take a moment, as always, to read the forward-looking statement on Slide two.

During today's conference call, we'll 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 on future events that are subject to risk and uncertainties.

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

As a reminder to all, we filed an 8-K with the SEC on April 9th detailing a few minor product category shifts between businesses, as well as the implementation of a new dual credit reporting model for those US based businesses that share customer channels to a certain degree.

In short, this change will serve as a catalyst to encourage US businesses to sell all 3M products.

The numbers presented in the press release today reflect those changes.

So let's begin today's review.

Turn to Slide number three and I'll turn things over to George.

Good morning, everyone.

And thank you very much for listening to our first quarter call.

The challenging quarter unfolded pretty much as expected, with the exception that like many of our contemporaries, the end markets were a bit tougher even than we had thought they would be.

While multiunits volumes were down [40 to 60%] with similar size contractions to this in electronics.

Housing starts continued to worsen even off an already gloomy base.

Net-net, we had expected organic sales volume to be down in the range 15% to 18%, but they came in slightly below that at minus 19.5%.

We predicted in our last call that this quarter would be the most challenging of the recession.

With the overall business conditions in Q1 were even weaker than we had forecast.

The run rate for sales for January, February and March were all very similar, so at the gross level, there was no material sign of recovery yet.

So it is indeed, as we predicted in January, getting worse before it gets better.

While it's not a surprise for us, one always hopes for better.

What we should all celebrate, however, that even with these massive volume declines, which are unprecedented in modern times for 3M, we maintained an overall operating margin at a stellar 17.1%.

The good news also is that we still made our internal operating plan [honerings] despite the volume shortfall.

That was obviously driven by a very tight and effective cost control by our leadership team and great performance in our factories, even with these significant volume declines.

On an FYI basis, the moving to stock option expense from the traditional second quarter to the first quarter negatively effected quarterly earnings by $0.04 and the loss of absorption on the sharp inventory corrections we've made in Q1 cost us about $0.07.

This does not include the effect of market-related volume falls.

There was also a loss in converting cash to dollars in Venezuela.

That cost us $0.02.

And Pat will discuss all of these items further in a few minutes.

We're obviously controlling all those things which are in our power to control.

In the quarter we announced a reduction in staffing levels across the world by another 1,200 people and we continued to streamline our manufacturing operations.

Indirect spending is running at 20% or so less than last year's levels, so we have the spending buttoned up tightly without, so far, negatively effecting our R&D spend.

We remain confirmed believers that we must still invest in innovation for as long as we can.

It's our future.

Business conditions in our industrial and transportation segment and electronic communications were very tough, as was the consumables portion of our safety and security business.

In contrast, healthcare remains reasonably robust, as did consumer and office, which continues to buck the trend.

Display and graphics saw large falls in sales too, but oddly, we began to see growth in eco-friendly TV component sales.

We had steady performance in traffic safety systems, renewable energy, and personal care products as well.

On the currency front, a third of the totally Company's sales decline for the quarter was due to FX impact of a negative 7.1%.

In the international markets, we saw an 11% FX translation headwind in the first quarter, a huge impact.

But in March, we saw more countries exceeding last year's local currency sales numbers than we had seen in either January or February.

There is a sense that the tiniest bit of momentum is building there, even if it turns out only to be the false dawn of inventory replenishment.

Those very early green chutes of improvement are, as might be expected, mostly the faster turn inventory businesses, such as electronics and flat panel TVs.

Pat will give you some more detail later, but I was pleased to see that our inventory has fallen substantially in the quarter.

We expect that this trend will continue for the next few quarters.

Our internal target is to reduce inventory over the balance of the full year by the same amount that we did in Q1.

Offsetting this a little, receivables increased in March for the first time in several months.

Now I'll turn the call over to Pat for some detail on the first quarter.

Pat?

Thanks, George.

And good morning, everyone.

On a GAAP reported basis, earnings were $0.74 per share versus last year's $1.38.

Excluding special items, this quarter's earnings were $0.81 per share, which, as George mentioned, was a few cents above our internal plan.

Pretax restructuring charges totaled $67 million in the first quarter, or $0.07 per share.

The majority of this amount related to severance costs associated with about 1,200 jobs that George has mentioned.

The reduction spanned all major geographies, both particular emphasis on the US, Latin America, and Western Europe.

On a business by business basis, the most significant reductions were in industrial and transportation, our largest segment.

And one that has been heavily impacted by the recession, and in corporate related to ongoing downsizing of our back office operations.

These reductions will save 3M $70 million annually with $40 million in 2009.

Restructuring is never easy.

But right sizing our cost base is absolutely necessary in light of much lower demand levels.

We have tried to be prudent, yet proactive with restructuring during this recession and since the second quarter of last year, we have reduced our global work force by 4,700 positions.

On top of this, we have also taken out significant number of contractors.

We have furloughed or temporarily laid off well over 1,000 others in response to slower sales.

The challenge, of course, is to balance short-term demand declines with longer-term resource needs.

We continue to work this balance every day.

You will see additional actions from 3M in the second quarter.

The size and scope of which are still being determined.

We had a few other items affecting both reported and adjusted Q1 earnings, that many of you may not or could not possibly have known about.

The first relates to stock option expense, where we just recently changed the timing of our annual employee stock option grant from May to February.

If you will recall, the retirement eligible portion of the annual option grant must be expensed at the time of the grant.

Now that we grant options in Q1 versus Q2 in previous years, the expense has shifted forward by one quarter.

This added about $0.04 per share of costs to this quarter that was not in last year's Q1 results.

Full year 2009 option expense will be very similar to 2008.

The details of this change were spelled out in our annual 10-K, but I know that some of you have waited to update your models until after earnings.

Second, we absorbed approximately $0.02 per share of costs related to our decision to swap Venezuelan [bolivar's] into US dollars.

Economic conditions in Venezuela have continued to deteriorate with escalating inflation pressuring their currency.

We are aggressively managing the cash flow risk as a result.

We expect to initiate further such swaps in 2009, costing somewhere in the range of $0.02 to $0.03 per share spread over the next three quarters.

Lastly, we aggressively reduced inventory levels in the first quarter, which negatively impacted gross margins by about 1.5 percentage points or the equivalent of about $0.07 per share.

Earnings exceeded our internal plan, and after considering these items, that may not have been factored into all your models fully, we believe our results were more favorable than they may appear on the surface.

Let's take a look at first quarter sales performance on Slide five.

This was a quarter unlike any that most of us have ever seen.

And while our businesses fought for every sales dollar, the degree of decline in some of our key markets could not be overcome.

For example, in consumer electronics, global manufacturing output contracted by anywhere between 20% and 50%.

Another example is automotive OEM, where global production is expected to decline year on year by almost 30% in 2009.

In the first quarter, North America alone, light vehicle production declined by 50%.

Taken together, electronics and automotive comprised almost one quarter of our revenues.

A number of other served industries declined at double-digit rates as well.

Digging into the numbers, worldwide 3M sales declined 21.3% in the first quarter.

Organic volumes declined 19.5% versus a previous expectation of down 15% to 18%, and the stronger US dollar reduced first quarter sales by about 7%.

On the positive side, we increased global selling prices by over 2% and acquisitions added over three points to sales.

Organic volume declines were most severe in Asia-Pacific at 24%, driven largely by the previously mentioned contraction in electronics, automotive, and basic manufacturing.

This had a significant impact on our display and graphics, electro communications, and industrial and transportations businesses.

The bright spot for A-Pac was in healthcare.

Which posted positive mid-digit, single-digit growth rates for the quarter.

US organic volumes declined 19.6%, with healthcare and consumer office declining in the mid single-digit range while our more economically sensitive businesses such as electro communications and industrial and transportation posted organic volume declines north of 30%.

Organic volumes declined 17% in Europe and 14% in the combined Latin America-Canada region.

On a more positive note, we have been able to hold prices such that last year's increases provided a net year on year benefit in Q1 of just over 2%.

Prices rose 3.5% in the US, 1.9% in Europe, and 8.7% in the combined Latin America and Canada region.

Of course much of the increase in Latin America was a direct offset to the impact of the strong US dollar.

Price declines by 1.5% in Asia-Pacific, this is all electronics related so there's no surprise there.

On a worldwide basis, sales and local currencies declined 13.9%.

Our strongest performers were healthcare at plus 2%, and consumer office, which was flat year on year.

Elsewhere in the portfolio, sales in local currencies declined by 3.6% in safety security protection services, 21% in industrial and transportation, 27% in display and graphics, and 30% in electro and communications.

Turn to Slide six please.

Despite sales being down 21%, we delivered an outstanding 17.1% operating margin in Q1.

Our business teams are really driving operational excellence to the bottom line during this difficult economic period.

Gross margins were 45.9%, down 2.5 points from last year's first quarter, with declining volumes in inventory reductions playing the most significant roles.

Many of our customers and most of our own businesses shut down their operations for some period of time in the first quarter.

Typically, we experience this in the fourth quarter, but obviously this is a different time.

We successfully reduced inventories in Q1, which helped our cash flow, but reduced gross margins by an estimated 1.5 points.

Regardless, it's the right way to run the business, particularly in this recession.

And although raw materials in general have declined, we turn mostly high priced inventory in Q1, given that we used FIFO accounting.

Also, the previously mentioned Venezuelan currency cost was booked to cost of goods sold.

This adjustment reduced gross margins by a little over 30 basis points.

SG&A spending discipline was good in Q1.

Costs were down 10% year on year, which obviously was not enough to keep up with the volume decline, but still reflects a lot of hard work by 3Mers in every business in every corner of the world.

We have talked extensively to you about our efforts to hold the line on G&A expense.

And in fact, we reduced these expenses by 14% in the quarter.

Our teams have gotten the message that maintaining cost discipline during this extraordinary recession is critical.

R&D expense was down 8.7% year on year, but up a point as a percent of sales to 6.3%.

As we have said many times during recessions like this, all areas of the Company need to tighten their belt, including the labs, but we are resisting the temptation to cut so deep as to jeopardize programs that will seed future growth.

We believe the 6% of sales is a healthy level of investment in the business.

Operating income was $870 million, down 42%, which again, was above our expectations.

This negative leverage was not surprising, considering our high gross margins, coupled with a 19.5% organic volume decline, but bear in mind that the inverse also holds true.

Net interest expense increased $19 million, driven primarily by higher net debt levels and lower yields on cash deposits.

The first quarter tax rate was 30.3%, down 1.5 points year on year due to continued excellent tax planning efforts and of course lower profit levels.

Just a few years ago, our tax rate was well north of 32%, so I'm pleased that we continue to make steady and sustainable progress on this front.

For 2009 in total, anticipate a tax rate slightly below 31%.

Net income was $563 million, down 43%.

As I mentioned, earnings per share was $0.81, a decline of 41%.

Now let's turn our attention to balance sheet and cash flow on Slide number seven.

Net working capital declined by a healthy $605 million year on year.

Inventory declined by $361 million and inventory turns declined slightly to four at quarter end.

Breaking down the $361 million of inventory decline, foreign exchange translation reduced the balance by $287 million.

However, acquisitions net of divestitures added $172 million for the quarter.

The remaining inventory reduction of $246 million represents the underlying difference between our factory output and sales.

We made some good progress in Q1, but we have more to go, as our 2009 inventory goal is to improve by a minimum of half a turn.

Accounts receivable decreased $677 million year on year and turns were 6.6 at quarter end.

Again, going through the pieces, foreign currency translation reduced receivables by $353 million and acquisitions net of divestitures added $144 million to the year on year balance.

The underlying reduction in receivables was therefore $468 million, which, of course, was directly related to a slower overall sales.

When we began to see the US economy slow in late 2007, we immediately put additional focus on managing customer credit and have heightened the awareness across our global operations as well.

We have seen some slowdown in customer payments during this period of tight credit, but thus far, nothing of an alarming nature.

And we will remain prudently cautious in extending terms until we are more confident that overall economic conditions and credit availability are back to normal levels.

Accounts payable declined $433 million versus last year, primarily due to much lower CapEx, raw material, and indirect spending during the quarter.

Free cash flow declined by $248 million year on year to $451 million.

Net income declined by $470 million, largely offset by a $461 million improvement in working capital performance.

CapEx declined by $54 million to $244 million in the quarter.

We expect full year CapEx to be $900 million, or down 40% versus 2008.

Pension-related contributions increased by $74 million year on year and restructuring cash payments increased by $96 million.

Finally, as many of you know, we have redesigned our incentive comp system.

Until recently, payments were made quarterly based upon the quarter's performance.

Whereas now they are paid in the first quarter following our assessment of annual business results.

This resulted in $55 million of higher cash outflows in the first quarter, which, of course, is offset in the other three quarters of the year.

Traditionally, our free cash flow conversion in the first quarter is the weakest of each year, due to the higher March sales compared to December, which negatively impacts our first quarter working capital performance.

Such was the case again this year.

Regardless, free cash flow conversion was 87% versus 70% in last year's first quarter.

Were it not for the timing change related to incentive comp, conversion would have been slightly greater than 100%.

We continue to target at a minimum of 100% conversion for 2009 in total.

Dividends paid to common shareholders totaled $354 million this quarter.

We once again raised the per share dividend by 2% in February, which was the 51st consecutive annual increase for the company.

Not many companies have this track record.

Finally, as I mentioned, on last quarter's call, our cash flow forecast for 2009 reflects no share repurchases.

Our preference at this moment is to preserve cash and maintain optimum liquidity.

That wraps up my comments on total company performance.

Now let's quickly review the performance of our business units.

I will review those segments most impacted by the current economic climate first, then conclude with those less impacted.

Please turn to Slide number eight.

The industrial transportation team is doing an outstanding job managing through end market declines, the likes of which the business has never experienced.

Three industries in particular, automotive, electronics and appliances touch about one half of industrial and transportation sale base.

So for example, when you see 50% declines in first quarter North American auto builds, a 25% contraction in January production of major appliances, and a 20 to 50% decline in global electronics, you can understand why our first quarter sales are what they were.

Sales in the business declined 28% to $1.58 billion and margins declined 10.2 points to 12.4%.

Sales in local currencies declined 21%, including a 2.8% benefit from acquisitions.

We have acquired some outstanding companies in the past year that compliment our business perfectly, including McGuires in the automotive after market space, along with [PolyFoam] and MP in the adhesives and sealants area to name a few .

The integration of these business has gone very well and we remain convinced they will add significant value to the franchise.

Given the market declines that I mentioned, it was not surprising that automotive OEM-related businesses were down over 40% in local currency.

The abrasives and industrial and adhesives and tapes business performed better, with local currency declines in the 20s.

On a more positive note, sales declined at only a mid single-digit rate in our renewable energy division and in automotive aftermarket.

Last, but not least, our performance care business posted slightly positive local currency growth in the quarter.

Looking at the business geographically, local currencies sales declined 4.8% in Latin America, 19.5% in Europe, 22.5% in the United States, and 26.2% in Asia-Pacific.

Sales in Japan in particular were down 36% in local currency.

The global ITD leadership team is aggressively managing through this recession, using all the tools available as necessary.

The announced restructuring actions in Q1, along with plant shutdowns, furloughs, and mandatory vacation across the operation, while the global economy continues to struggle.

Industrial and transportation will be well positioned for stellar sales and profit growth once the global economy begins to rebound.

Please turn to Slide number nine where I will comment on the performance of our electro and communication businesses.

This business is also working hard to overcome significant end market declines.

About half of the electro and communications business is linked in some fashion to the global electronics industry.

So the mega declines I mentioned on the prior chart were a factor here as well.

Semiconductor shipments, which impact our carrier tape business were down 30% in the quarter.

The remainder of electro and communications is largely tied to infrastructure, including non-residential construction, power transmission and distribution, and telecom, all of which are projected to be down more than 20% in 2009.

So our electro communications team had its hands full in the first quarter as well.

Sales were $480 million in the quarter down 35% year on year and profits were a positive $24 million.

Sales were down 30% in local currencies, with near 20% declines in telecom and electrical products and 40% plus declines in those businesses that serve the electronics industry.

Local currency declines 39% in the United States, 35% in Asia-Pacific, 17% in Europe, and 14% in Latin America.

Now please turn to Slide ten and let's take a look at our display and graphics business.

This business has been -- seen aggressive inventory adjustments and end market contractions as a result of both the commoditization of optical films and of course the global recession.

Sales were down 30% in dollars and 27% local currency compared to last year's first quarter.

Profits declined 65% to $66 million.

Sales in our optical systems business declined 44% in the quarter and profits were down 75%.

As we have discussed on prior calls, optical has transitioned from being a very high growth business to one that is much more mature.

The most significant part of this transition began in the second quarter last year.

Therefore, year on year comparisons remain quite difficult in the first quarter.

These challenging year on year comparisons will begin to wane starting in Q2.

The year on year decline in optical systems reduced the overall sales growth for D&G by 12 percentage points.

On a more positive note, our optical team was successful in developing a number of new film solutions for what is commonly called eco TV.

3M's proprietary multi-layer film solutions enable an OEM to produce a more energy efficient LCD TV by using fewer bulbs in combination with our films.

We are gaining some nice traction in this area.

Sales in our commercial graphics business were down 27%, as customers have cut back on branding, media, and advertising plans.

They, too, are wrestling with this challenging global recession.

On the positive side, sales in traffic safety systems were about flat in local currency.

This business is anticipating some boosts in sales this year, from the recent Washington stimulus package.

A portion of which is expected to be used for highway infrastructure projects.

Now please turn to Slide 11, where I will discuss details of our safety, security and protection service business.

Sales declined 15% in the first quarter in this business to $694 million.

In local currency terms, sales declined only 3.6% with acquisitions adding 10.6 points to first quarter growth.

Operating income declined 34% to $129 million and margins remained at a very healthy 18.6%.

A good performance, considering the economic environment.

Double-digit declines in most industrial end markets drove near 20% organic local currency sales declines in personal Protection Products, which is the largest business within safety, security and protection services.

In our securities systems business, which is not economically cyclical, local currency growth is down just a few points.

In terms of new business development, our securities systems team successfully closed yet another passport supply contract during the quarter, this time to a prominent country within Europe.

The 2008 divestiture of High Jump software business negatively impacted sales growth by 2.2% in the quarter.

Please turn to Slide 12, where I will recap the quarter for our consumer and office business.

This business turned in a stellar performance in the first quarter, considering that both businesses and consumers both retrenched cutting back significantly on their spending.

While worldwide sales contracted by 7%, this was all currency related.

Sales and local currency were flat year on year, which included approximately three points from acquisitions.

In the fourth quarter of 2008, we acquired [Perturo] a leading supplier of compression supports and hosiery, which complements our existing consumer retail healthcare business.

In addition, the retail portion of Arrow, a company we acquired in April of 2008, was assigned to the consumer office business in January 2009.

In the US, we delivered 4.5% sales growth, despite significant declines of foot traffic in most large retailers.

We achieved this result in two ways.

One, the Perturo and Arrow acquisitions added four points to the US growth.

And two, we continue to drive penetration of new and existing products throughout our customer base, again, despite negative same-store sales.

A great example of this is our branded Filtrete business, where new products combined with innovative merchandising programs are driving strong double-digit growth.

So again, despite tough end market conditions, this business did a great job in the first quarter.

Now, please turn to Slide 13, where I will discuss the results from our most profitable segment, healthcare.

This was definitely the bright spot in our portfolio in the first quarter.

Local currency sales increased by two percentage points.

Organically, prices offset volume declines and acquisitions added two points.

Currency impacts sales by almost ten points, so total sales declined 8% to just under $1 billion.

Local currency growth was led by the oral care and medical businesses, along with solid performance in all international regions.

Health information systems was about flat year on year.

Our drug delivery systems business posted local currency sales declines in Q1, but are expected to turn positive in the second half of the year.

This business does have a tendency to be a little lumpy when measuring quarters.

Operating margins were an outstanding 31.2% in healthcare, a year on year increase of 1.4%.

So despite the 8% sales decline, profits were down just 3% in the quarter.

And as in consumer office, profits would have been flat year on year were it not for the timing change with stock options.

That wraps up my discussion of the portfolio, so now I will turn it back to George, who will describe our 2009 outlook.

Thank you very much, Pat.

The question I think you're going to be most interested in is what about the balance of the year.

I think we all know that this subject is very complex to explain, but I'll try to give you the best verbal description I can of how we expect the year to unfold by a couple of charts.

We all know that loan cycle businesses have far better order visibility than we do.

So a view on the economy's performance rather than on an order book, is the key to how we see the forecast and balance of the year.

In 3M's case, it's all happening realtime.

So the good news is that the economic pressure will also subside here first.

We are in fact a good Bellwether of what is happening to the economy on a realtime basis.

Our internal economic forecast suggests mildly weaker end market conditions in Q2 than those we saw in Q1.

So we still expect a little more downward momentum in the economy in Q2, though the rate of sequential decline, the second derivative, shall we say, is likely to get a little bit better from here on in.

That view is also support by external econometric models.

To offset this continued market weakening, cost reductions from recent restructurings and other actions that we have taken will take greater hold in Q2 than they did in Q1.

Additionally, toward the middle or later part of the quarter, I expect that some of the inventory correction transients, which have caused such steep declines in sales for everyone will subside, too, particularly in our faster inventory turning businesses such as electronics.

That will probably begin in Q2, but we should see its full effect somewhere in Q3.

We have a couple of pretty tough quarters behind us and likely one or possibly two more in front of us.

While most of us believe the world economy will recover in due course, few have the knowledge or the confidence to predict when that recovery might be.

But whether we like it or not, at this time and at some level, we're all in the forecasting business.

I don't think it's enough just to say I don't know.

So on that topic, it is our view that the US economy will bottom somewhere between the end of the second and the end of the third quarter.

We'll probably see sequential quarter over quarter improvements after that, but we're not returning to the same level of economic activity that we had in 2007 until 2011.

I also think Europe will lag a US recovery by a quarter or two.

Some observers are a little more optimistic than me on this European topic, suggesting a European recovery will return parallel to the United States, but I'm not so sure.

Asia, with the exception of Japan, should actually help lead us out of the recession and in the Vanguard of that movement regionally will be China.

And market wise it will be electronics and the internal Chinese economy.

There is no reason to believe that automotive in the region or anywhere else for that matter will improve any time soon.

That will be driven by customer -- consumer confidence, which is likely to lag real improvements in the economy.

Electronics markets apart, it's hard to see any good news emerging in [each of our] economy into 2010.

What makes this year so difficult to predict accurately is that it's a huge year of transitions, both in volume shrinkage, as end markets decline, supply chains drained, but also the reverse, as pipelines refill, albeit to some lower level consistent with weaker end markets.

The dynamics which applied to pipeline emptying should generally also apply to pipeline filling.

But I think the filling will likely stutter a bit at first, perhaps introducing a bit of [hysterics] into the system.

The restart will probably be affected by shortages of business credit and the need for building greater business confidence.

And then after that has happened, pipelines will probably fill fast.

The key we have effecting our recovery is three-fold.

Business credit availability, growing unemployment, and candidly, low aggregate demand.

Stimulus packages are in important longer turn, but I think their effect is limited short-term, particularly in the United States.

So to be very clear here, we've not included in our forecast any fast refill of inventory pipelines, even though it is likely to happen when the economy eventually makes the turn.

What is unknown with any degree of accuracy is how much of the organic volume decline in Q1 was due to weak end market conditions and how much was due to inventory corrections in the various distribution channels that we use.

If we use blended IPI data as an indicator, and I'll just remind you that the worldwide IPI Q1 forecast was minus 13.6%, it would suggest that about a third of the organic volume decline at 3M was due to inventory corrections.

But it is clearly difficult to know with any certainty, but as [keenly] said we are looking for directional accuracy here, not absolute precision.

I think the severity of the end market contractions and the consequent greater difficulty, and quickly driving gout excess inventory will make the channel implicitly less efficient at clearing inventory than it would have been as the sales falls were less severe.

So the effect of this is that it would possibly stretch out the period where sales would be depressed due to this inventory correction factor.

In terms of forecasting, the two quarters [we stream the year] are the late second and the fourth.

The second, because that is when the inventory trends I mentioned should begin to die down in some businesses.

And the fourth quarter, because that is when year-over-year comparisons turn in our favor.

So in summary, we expect the second quarter end markets to be similar or possibly a bit worse than Q1 in the early part of the quarter, with improving results toward the end.

The timing of any improvement in our wholesale sales in Q2 is much more connected to the clearing of excess inventory than it is to any material improvements in our end markets.

I do not expect to see much in the way of end market improvements until at least Q3, or possibly even Q4.

At 3M, we expect Q3 to show sequential improvements over Q2, as more channels finish drawing down inventory and some end markets also begin to improve slightly.

Our modeling also shows Q4 to have marginally better end market conditions than Q3.

I think all of these factors together, the year will turn out to be somewhat more challenging than we had originally expected.

We believe that organic sales volumes will come in somewhere between minus 11% and minus 15% and that EPS will come in somewhere in the band of $3.90 to $4.30.

We now give you a bridge to the $3.90 EPS number.

Please turn to Slide 15.

Assuming that we are at, or close to dragging bottom on end market sales, and we believe that we are, the best level of formation this calculation would be Q1's $0.81 multiplied by four, which yields $3.24.

As we've already mentioned, because first quarter stock option expense is the highest of the year, we realize the benefit spread out evenly over the year of $0.11 versus the Q1 run rate, that takes us to $3.35.

In Q2, we expect to see take-up of an early retirement program we've just begun.

We'll also do some further restructuring, principally in Asia, and in Western Europe.

In combination with previous actions, this restructuring adds another $0.20 to the year.

We also expect vacation policy changes that we've talked to you about before to add $0.08.

This gets us to a subtotal of $3.63.

Moving on to the next item on the chart, even in a recessionary environment, many of our businesses will still see seasonal upticks later in the year, as opposed to the first quarter.

Example includes consumer and office, and their back-to-school and holiday orders, and traffic safety systems linked to the road construction season.

The year end holiday's also boost consumer electronics.

Considering these patents, we expect about $0.16 of additional profit versus the Q1 run rate, which takes us to $3.79.

Finally, this low end scenario would put us well below our original operating plan, resulting in lower variable incentive compensation versus the Q1 run rate.

This would add $0.11 cents to earnings.

Adding it all up, we believe that $3.90 per share is a reasonable estimate on the low end, again, using Q1 as our base.

Other than the seasonality issue, the low end of our range assumes no improvement in sales volumes for the entire year, which we don't believe will be the case.

Let's think about this.

A year where end markets were as bad as Q1 and excess inventory takes all year to clear the channel is highly unlikely without the influence of another, as yet unknown financial or other catastrophe.

So we believe that there will indeed be some additional volume increases and I'll discuss that when I walk through the high end scenario in just a minute.

To get to the high end of our range, we vary only volume.

Four points of additional growth, which represents the difference between our high end and low end volume assumptions, would yield $0.45 of additional earnings for the year, with corresponding variable comp adjustment of $0.06, which is included in that total.

Now, this puts the high end at $4.30 for the year.

We've not included in our calculations for either end of the range is the likely benefit from better inventory absorption in the remainder of the year.

In the first quarter, it had a negative effect of $0.07.

We think this will be the highest such impact of any quarter in 2009, leading to a possible benefit in the range of $0.14 for the balance of the year.

This should give us some cushion against the unknowns.

While nobody, me included, likes to reduce forecast, this estimate reflects our best thinking about the year at this moment.

It also reflects [Youhmen's] work by the good people at 3M and this quite unprecedented fall in economic activity around the world and the large currency head winds that we still face.

As you can see, we remain very positive in our attitudes and outlook, figuring we're now about half to two-thirds of the way through the knot hole before the turn in the economy comes.

So we feel there's no more to go through than we've been through already and we know how to deal with it.

A process of Darwinian economics is unfolding in the marketplace as the recession continues and we're gaining share in many places.

Customers are recognizing the benefits of being with a great and reliable partner like 3M.

We're also fortunate that we can invest in the future in a way that many of our competitors and peers cannot right now and yet still make great margins.

We clearly intend to become stronger on a relative basis during this tough time.

We continue to be focused on cash generation as the best means of innoculating us against the downturn and R&D is the best way to prepare us for the future.

The logic that we will come out of this faster than -- long cycle peers is compelling and we continue to see our Company's a great place to invest right now and a great place to be in these times.

With that, I would like to turn the call over to the questions.

Thank you, very much, for listening.

(Operator Instructions).

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

Please proceed with your question.

Thank you, good morning.

Good morning, David.

George, your outlook is a little more cautious than others I've spoken with in the last week and a half in terms of signs of sequential improvement over the last few weeks.

First off, is your April tracking better than March?

And what is unique about your business that would suggest you might lag some of your material peers in seeing some sequential improvement in demand?

Thanks, David.

I think that April is running about same as March right now.

I, I said in my conversation here, David, that I think that there's obviously going to be a little bit of wash over from the first quarter into the second.

But toward the end of the second quarter, I think that things are going to begin to turn.

I also mentioned that we have seen some improvements in some of the faster turning businesses, even a little bit in industrial.

We obviously don't want to get out ahead of this thing in the way we're interpreting it and trying to be cautious and balanced in our opinions about this.

But I think we're also pretty clear, David, that the economy will make the turn by the end of the second.

If the cycle is a little longer than historical experience, it might, it might take another quarter.

But we're pretty certain that we'll see some improvements in the second, David, and then continuing improvements in the third.

You just got to be careful that in the second, I think what's likely to happen, David, is some inventory transients are going to die down and that's probably where you're going to see the improvements.

So I think we'll see improvement in the numbers, but not necessarily in the end markets.

That's very helpful.

And just lastly on pricing versus raws, as your raws drop, do you think you'll hold onto pricing and what could the impact be through the full course of the year as that gap widens?

Well, Dave, what we're trying to do is have the best of all worlds, okay.

We'll try to hold on to the price.

We definitely see raw materials coming down.

But as we think about it on a business by business basis across Company, we're obviously trying to manage the spread between price of raw materials.

So if you notice in George's [wapoquay] coming off of Q1, you won't see price or materials embedded in there anyplace.

The reality is we know material prices are coming down, probably order of magnitude of $100 million or so for the rest of the year.

But for this modeling and so forth, we have not done anything from a profit improvement on that, because to some degree we'll probably have to give up a little bit of price in the back half of the year.

I think, Dave, there is kind of a race condition that's going to take place.

Right now, our price seems to be holding okay.

We're not seeing sort of intense pressure that some people perhaps thought.

But I think it's clear that if the economy doesn't improve, we will see that, that pressure.

And as Pat said, the trick is to manage the spread between price and raw materials.

I also think there's a risk condition taking place between pressure on price and upward pressure on the economy.

And if the economy responds a little better than some of us might think, then I think that pressure goes away and the year ends up being quite positive.

Very helpful.

Thank you.

Thanks, David.

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

Please proceed with your question.

Thank you.

Good morning.

Good morning, Scott.

Just a question on Asia, George if you could drill a little bit further into that.

Interesting that it was actually the weakest geography from a local currency standpoint.

To what degree do you think that is kind of the export-related phenomenon into the developed worlds, developed world, or how much of it is really kind of organic weakness in those end markets?

And I guess the gist of my question is you're still relatively low penetration in some of those Asian markets.

What is the opportunity in the downturn to push penetration higher?

Well, if you take -- thanks, Jeff, if you take Japan as probably the, almost sort of a poster child for what can go wrong in Asia, their market is really concerning three things.

Automotive, electronics, and machine tools.

And they have all been just absolutely pummeled, as you well know.

So I think that it answers the question implicitly that you talked about, that certainly in Asia, we map this, Jeff, in Asia, more of the economy is tied to exports than any other region of the world.

Obviously the United States and Asia -- excuse me, Europe included in that.

So I think you're absolutely right, David.

It's driven by export.

But what's beginning to happen is some of these economies are now doing internal sort of in-country stimulus, China being perhaps the best example of that.

And their economy is responding.

So it may be that we'll see the initial betterment in the economy coming from internal stimulus packages, Jeff.

And then obviously in turn as the rest of the world begins to pull its socks up and begin to improve, we'll see that pull through into Asia.

So I think it is, as you rightly point out, it's because of the export-led nature of that particular economy.

Japan is really the worst of the examples for us.

China is not doing all that badly and we expect it to begin to do better.

And probably, as I mentioned in my comments, I think Asia will certainly be at the front, if not lead, it will certainly be along the United States in leading us out of recession.

And on pension, Pat, if you were to lock down on current returns and discount rates, can you give us some view of what type of head wind you look at in 2010 on pension?

Good question, Jeff.

Hopefully I'll lock down on where we're currently at.

What we're having a tendency to model is what happens if we get back to kind of a zero return for the year and discount rates don't change?

Now the reality is discount rates have moved, okay, pretty significantly.

So if I took a balanced view, we're probably looking someplace on the order of about $200 million a year on year hit from 2009 to 2010 relative to our pension expense.

Let's face it, that number's going to be volatile.

We'll see when we get to the end of the year, but if I was to model today, 0% asset return in kind of a flat discount market, give us about $200 million hit year on year.

Thank you very much.

Our next question comes from the line of Scott Davis with Morgan Stanley.

Please proceed with your question.

Sure.

Hi, good morning, guys.

Good morning, Scott.

I know you buy a lot of different materials and the prices changed pretty drastically particularly in the last, more towards the end of last year and early this year.

How much -- Pat, how much do you think FIFO helped you out in the quarter, if at all?

I don't think it helped us at all in -- well, we still think we're probably going through, Scott, about the peak, okay, of our material costs in Q1, probably a little bit average between Q4 and Q1, so back half maybe got a little benefit.

But the slower volumes here in the first quarter, okay, really kind of hurt our ability to get through the higher cost layer as fast as we would have liked to.

So I would say Q1 is kind of the -- at the high level relative to cost of goods sold.

Okay.

And I know, I know I asked this question last quarter, but I'm just curious to see if it's changed at all.

I mean when you think about the big picture, the supply chain fix that you have is kind of a seven-year gig that you talked about, but you can make an argument that this restructuring pulls forward a lot of that and helps you prepare for the next up cycle.

How do you guys think about -- I mean is that real, or am I kind of thinking that incorrectly?

Let me -- I'll answer the way I will and then George can pipe in.

The -- our supply chain efforts are continuing on.

It's a day-to-day exercise, so there's two sides to this.

One is that as we've cut back our CapEx spending, it has somewhat probably slowed down some of our longer-term moves that we were looking to make.

Partially because we just don't have some of the demand that we needed, which was going to put some of our facilities inI'll call it better -- from a better local supply standpoint.

So to some degree, that has slowed some of that effort down as far as a, kind of a longer term, larger CapEx investment.

So some of those plans have, have kind of slowed down a little bit.

But I'll call it the untangling of the hair ball George has talked to a lot of you about, is that's a day-to-day effort, plant by plant, it's product by-product, it's process by process, and all that stuff continues to go on.

But to be fair, there are some pieces that had to do with some longer-term, bigger moves that we had in mind that we have put on the back burner here for at least the near term.

So what it will do, Scott, is basically -- it will push that -- those supply chain initiatives essentially to the right for a year.

And to just underscore Pat's point, there were really three elements.

One was the building of local plants close to markets, which was the stuff that was visible in that 17, 18, 19 plant builds.

There was a second element of this, again, which was about capacity adding, which was the building of super hubs that really look to the future about where the demand might be in trying to locate the sort of plants with multiple businesses in them that could respond regionally.

Then the third one, which Pat sort of mentioned, was this internal hair ball back in the United States, where we had multiple plant shunts.

That kind of -- and that didn't include, or didn't need either the opening or closing of plants.

That's ongoing.

We're doing that.

And that will bring its benefit.

So you are right in the sense that that's still ongoing and will deliver benefits later on in working capital improvements and overall efficiency and fill rates I think.

But to be fair, the other part -- the other elements of it will get slipped to the right.

Okay.

That's helpful.

Thanks, guys.

Thanks, Scott.

Thanks, Scott.

Our next question comes from the line of [Stephen Whitaker] with Sanford Bernstein.

Please proceed with your question.

Good morning.

Good morning.

Hi, Steve.

First question I have is on operating leverage.

As I think about the cost reductions going on, the operating leverage in the first quarter was 1.9 times on my math.

Which implies on the low end of the guidance or the range of the guidance, about 0.5 to 0.8 for the rest of the year, so a significant improvement.

And you've talked about a bunch of the cost reduction actions, but could you maybe give a little bit more color for sort of what, what really has to go right to hit that kind of betterment on the operating leverage side?

Yes, first of all, Steve, the models don't always work the same going down as they do on the upside.

You've got a fair amount of fixed costs in the business and so forth.

And when you've got, especially a relatively large manufacturing organization, even though you try your hardest to try to take all inventory out of the system and run lean and so forth, there is a certain element of inefficiency that you have in your manufacturing processes when volumes contract as rapidly as they have.

You just can't completely right size all of your manufacturing, your supply chains overnight.

So there's an element of inefficiency that does happen on the downside, especially in the very dramatic decline scenario.

On the upside, the way I think of it is, we've laid out a number of restructuring actions that we're talking about.

What's critical to us, though, we've got to hold the line on our staffing levels and our spending when volume comes back.

And so we got very stringent controls in place to make sure that our, both our spending and staffing levels hold at current levels until it's very, very clear that there truly is a long-term volume uptick here to make sure you don't get a bunch of false positives and you start to respond prematurely.

So we have to actually get the restructuring.

We have to continue to focus on gaining share where we can, and get some additional business.

But importantly, we have to get the leverage here on the upside.

What we tell the business is we spend money to restructure your business.

We can't be putting these people back in when the volume returns.

So we've got to become a leaner, organization as volume comes back.

Does that imply a certain amount of capacity reduction across the business that you could sort of quantify order of magnitude?

No, I wouldn't say -- it's very -- not on a large scale.

I wouldn't say that we're taking a lot of, a lot of plants out.

We will be altering some of our more developed market supply chains.

Back to Scott's question a little bit, which is just kind of a normal piece of business.

It's fair to say we have a fair amount at this level, we have a fair amount of excess capacity.

But when you look at -- we don't see this as being a permanent, a permanent volume level.

It's very clear that maybe it doesn't bounce back in the next six months, but as George kind of outlined, by probably 2011 or so, we're back to 2007 levels.

So we're not going to rip up our capacity and our structure in response to the current, the current conditions.

Meantime, we've got to do some extraordinary efforts here to make sure that we bring down the costs and are really able to maintain our capability on a long-term basis.

One of the things that we're looking to do is to bring in a bunch of business from the outside into some of our plants to fully utilize it and so forth.

So we have a number of those actions going on, Steve.

Okay.

And then just finally, on your five-year product vitality index, which was I guess about 25% or so in 2008 and I thought it would be more than 30% this year, is that still the number that you're targeting, or how are you -- what number are you looking for this year?

It's, it's -- Fred just gave us the report just the other day and it's gone up by another couple of points.

Whether by the end of the year it makes in the 30s is yet to be, is yet to be determined.

Obviously you've got overall sales falls, both new product and replacement products.

But I think we will continue to take meaningful and helpful steps down that pathway.

So I think overall news will be positive, even if it's not exactly that number that you just mentioned.

And, Steve, one of the bright lights here is that if you go back and track that metric for a period of time, so much of that new product vitality metric used to be optical.

Now it's made up of broad-based business growth across all the divisions of the Company.

So it's a lot, it's a lot solider development program that we've got going on now.

That number, that number, Steve, back in the optical heyday, in the 2004, 2005 timeframe was down, for the core of 3M was down in single digits.

So what it tells you is the, is the underlying health at the core of the business and the innovation in the core of business is very, very strong, very, very much alive and well.

And it's not going to take very many, very many years, maybe only another couple to really get this back to the point where we -- it's going to be the engine in a sense that drives that underlying 5% to 8% organic growth Pat and I are looking for.

All these economic downturns notwithstanding.

Thank you.

Thanks, Steve.

Our next question comes from the line of John McNulty with Credit Suisse.

Please proceed with your question.

Yes, good morning, guys.

Good morning, John.

With regard to working capital, you certainly made some headway, but clearly not probably as much as you wanted to, given that you've still got some inventories you need to work down and there's some high cost inventory as well.

Can you give us some color as to what you think you can squeeze out of working capital throughout the rest of the year to help drive the cash flow?

Well, John, let me try to deal with inventory, kind of in isolation here for a second.

We probably need to make a, about the same level of improvement.

If you wash out FX and acquisitions, we had about $250 million for the period here.

We probably need to make another similar improvement over the rest the rest of the year; would be the level of improvement.

The thing on receivables, receivables is so sales volume dependent, we will maintain our days outstanding I think in a relatively tight position.

But it will vary depending upon what volume scenario you're looking at.

Okay, great.

And then just one other question with regard to cash flow.

Your balance sheet's in pretty solid shape at this point, there are a lot of companies out there that are struggling, any reason to think that you're maybe stepping up into the M&A markets a little more aggressively would make sense for you at this point?

Well, you have to keep an eye on what the marketplace is.

And, of course, we're trying to balance the combination of our liquidity or credit position in the market as well.

So we'll take a look at all of those.

For the right kind of deal, the right kind of value, we will continue to entertain those for the long-term health of the Company.

I think, John, the -- in the rare places where we've touched this, we're not finding companies who are perhaps as realistic on prices.

Many people from the outside looking in might think.

So in some ironic way, if this continues for a little bit longer, I think that situation's going to change.

Some of those people are going to be perhaps more incentivized to listen more sensibly.

So I think the longer it goes on, the more likely that kind of issue is.

But we're just going to have to see, as Pat said, we'll take it on a case by case basis.

Great, thanks a lot.

Thanks, John.

Thanks, John.

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

Please proceed with your question.

Thank you, good morning.

Good morning, John.

Good morning.

So George, I think you mentioned flat panel TVs were looking better.

Yes.

My question is, I know if you go back in time, we had sort of talked, or we as in you had sort of talked about being designed out of a lot of this stuff.

Is flat panel TV going forward still significant?

Maybe you could dove tail that with a little bit of this eco friendly product you've got.

Like how significant could flat panel be for you in an up cycle if volumes for televisions improve?

Well it's, it's an amazing, an amazing thing, John.

It's like for the tidal ebbs and flows in this business.

So much of this design and design out is realtime and these guys in the end markets Samsung, LG, Sony, they are in really, really tough markets.

And so they use, they use innovation.

They use latest mega trends as a means of driving their volume.

And one of the obvious mega trends has been -- and it's really right across the industry, John.

It's in the battery-powered devices, it's a drive towards extended battery life.

In the electrically powered devices, it's a drive toward lower energy costs.

And the beauty of the kind of films that 3M has, films which are protected by, by intellectual property, I'm thinking in particular multilayer film, [DBef] are the ones that give you this facility.

So what's actually happening now, John, a lot of the panel manufacturers are able to get from four down to two lamps or eight lamps down to five.

And get 30, 40, or even a little more out of the, energy out of the panel.

And when you, when you realize that they are saving on lamps and they are saving on inverters and they are putting in films, it's actually more or less a net trade.

And so the end, the end customer, assuming that the panel manufacturers can find it in their way to pass this through to the set manufacturers and then to the retail customers, you can have today a set consuming roughly 40% less of the energy for the same price as you could the one to its right does not.

And so that seems to be gathering a lot of momentum, John, and it really is taking hold in the marketplace.

So I think that in terms of just square footage of film manufacturing, it's probably pretty good upside.

But all of us being burned by the commoditization of this particular market, so I'm not going to get out ahead of myself.

But I do think that significant increases in volume, John, of course muted by price, and affected by what kind of film it is on margin wise.

But nevertheless, I think this has the possibility, John, in a perverse and ironic twist of history, of giving us a little bit of upside in the display and graphics market.

So all those conversations that you and I have had about this market, which are very challenging, may get better in the, in the coming months.

The trick, John, still is to make sure all of the high margin business, the better performing businesses, like handhelds, don't see, don't see some similar switches in technology to what TV did.

It's not happening yet, John, but it's something that we are -- having once been burned, we are very aware of.

So I think overall the news is more positive than it once was.

And I think and John, I just want to make sure you don't misread anything we say.

It's not going to go back to where it was.

It's never going to go back, John.

But definitely is sequentially better than the performance in the TV section during the past year.

In fact even it in this quarter, John, even though we report year-over-year numbers, if you look sequentially, fourth quarter to first quarter, very significant improvements in profit in that business and in margin in that business.

So the -- certainly the trend has turned.

George, I know you guys had shuttered capacity in optical film.

Given what you're describing are you now, would you characterize your situation as being right sized to be able to benefit from this trend?

Or would you foresee even possibly adding a little bit of capacity down the road?

No, I don't think there's any capacity needed, John.

Where we shuttered some capacity has been in the converters, the guys really out in Asia for the most part.

The manufacturing capacity here is not being shuttered.

There is some manufacturing capacity, John, being repurposed for window films, which are obviously being driven by the, the interest in ecology and interest in energy consumption.

So, no, I think we're okay right now.

As much of this we can get, Pat and I will be dancing in the streets.

And do you guys have a sense of what your global capacity utilization might be with respect to volumes?

I'm trying to think of a little bit of the opportunity to reabsorb some fixed costs as volumes at some point come back and sort of trying to bridge a little bit of the upside/downside scenario you've presented in the 2009.

John, I'll let George take a shot.

To be perfectly honest, we don't -- our businesses are so different, our processes are so different from a capacity perspective, it's giving you a number is, is kind of interesting and my guess is probably in the 70s, 70 range, 70s range is kind of where, as I think about it.

We've got extreme examples.

Okay.

You got businesses and consumers today that are running very, very well.

Healthcare is running very, very well.

Industrial and electro communications, of course, we got some plants that are running a third.

Okay?

So you got sizable spreads across the portfolio.

In renewable energy, John, we can't keep up with the demand.

In diaper tapes, it's the same issue, really very very rapid growth, but yet you've got other things automotive related that are at the opposite end.

So I think it really is -- Pat's absolutely right.

Hard to give you a blended number, but it's probably within, within a couple of points of 70%.

Okay, and then just lastly, could you remind was your exposure is roughly to commercial construction?

I'm just trying to think of -- you're clearly a short cycle Company.

I'm just trying to think are, there temperments we should be cognizant of, just as those end markets kind of --

John, I wouldn't even worry -- I mean it's not a significant piece.

It would be at best a couple points.

Okay?

I would have to probably round up to get there.

It's -- and so it's mostly residential, John.

And, we began to see that going back really to the end of 2006.

So we've lived through most of the construction misery that's likely to be thrown at us.

Terrific.

Thanks very much.

Thanks, John.

Our next question comes from the line of Steve Tusa with JPMorgan.

Please proceed with your question.

Hi, good morning.

Good morning, Steve.

I have a question, George.

When you first came in, it was a little bit bumpy with regards to the visibility on the D&G issue, and obviously, we've had a tough economy for the last six to nine months and nobody's been very good at predicting things.

What gives you the confidence now to use the term bottom?

And are you comfortable that you've been around here long enough now and you've been engrained in the culture and are comfortable with your systems enough so that you think you have the visibility to make that kind of comment?

If you could just comment on that, that would be great.

Sure, Steve.

I sort of alluded that it's a little bit early in the conference call, Steve, when I said we, we can't take a view on the, on what's happening from an order book because our order books are typically 30 days out.

And there isn't going to be a change materially anyway in 30 days out.

So we have to build other kind of models about how the, we believe the economy will respond.

Our observations are based on those, on those models.

We've looked at historical models by analyzing the recessions going right over the last 100 years in the United States, looking at length of cycles, how much of the time they spend in recession, how deep they are.

Looking at the last cycles, looking at the longest cycles, the shortest cycles.

And we built a model that leads us to the conclusion that I iterated Steve a bottom somewhere between -- this is end markets, Steve, not necessarily wholesale markets.

Because obviously if you see a transient in the end market rippled back through it's supply and is often magnified that's why you see IPI in the first quarter at 13, but you see, say our sales and ITW sales and other company's sales down in the 20s.

Because the challenge is clearing the inventory out.

And what is so key to making an assessment on the year, Steve, is how fast that inventory might clear out, so you could actually -- and the perverse nature of this, Steve, is you could have those inventory transients die down, where wholesale and retail, shall we call it that, for want of a better description, are [in stasis] or a match, but you seen an improvement from down 21 to down 13.

It's still miserable, but at least it's an improvement.

So we, we are not expecting, Steve, any significant improvements in the end markets.

But we have to take a view on how the economy is doing.

We have to take a view on how efficient the channel is clearing out inventory and rolling up these kind of forecasts.

As to what generally happens in the economy.

But oddly enough, if you take the way that I rolled up the numbers and the way that Pat rolled up the numbers, you take that first quarter performance and you add a little bit of stock option back in, you add a little bit of Venezuela back in and even a little bit of the inventory correction stuff back in and then systematically things that we know we can control, the vacation, the restructuring which is going to come to us, makes the assumption that we hold the costs constant, Steve.

And a few other bits and pieces and it looks to us like we can get to the -- it looks like we can get to the $3.90, even if the economy doesn't improve all year.

So we, we just can't bring ourselves from all that we know from the green chutes that we know, from the performance of the channels in electronics for example that we know, we can't get ourselves to the point where we, we -- where we think that anything significantly worse than that $3.90 would come in.

So it's just a lot harder, Steve.

And you know this business very well.

It's just harder to make an assessment in a Company like this because we don't have an order book, so you got to make those assessments of the channel.

And you got to make those assessments of the market, and they are the ones that we've made.

Great.

And then just one more big picture question.

You guys touched consumer in a lot of areas and you've got a great R&D budget and spent a lot on marketing and I'm sure you study this every day.

From the feedback from your guys, is there any risk that there is a kind of structural change here in the consumer behavior, that's not as temporary as some might think?

It's kind of a structural tradedown that there's risk that 3M will not get paid for the kind of innovation that they have gotten paid for historically.

Is there any concern around that kind of dynamic as we go into this less leverage world where people just feel a little less rich?

It's an interesting question, Steve.

It really is.

I think the -- you can answer this at two or three levels.

I'm an import to this country, but I do observe about my wonderful adopted countrymen that old habits die hard.

And so the consumer, at the consumer level, I think that kind of behavior pattern probably won't last.

It doesn't mean that there won't be a little bit of lag, Steve, but I don't think it will last.

Now, in the industrial spaces, Steve, I think the question is a little tougher.

Certainly what we've really kind of found is a combination of things, Steve, is some people moving down the market.

We classically describe the market as good, better, best.

But what we've actually, we kind of draw it as a [parabridge] with a smaller top and a wider bottom.

But what's actually happened, Lowell made a great point about this.

What he's seeing is the pyramid changing to an hourglass.

Where the middle is shrinking and people are either moving up to better products, more reliable suppliers, people they can turn to in tough times, and to some degree, those who are in troubles moving down markets and expanding bottom of the markets.

But what we've done, and it's really happened -- I think you were there, Steve, the first time I ever presented to this group in this Company, we talked about how we can capture some of the bottom of the market, not only for growth opportunities, but as [bullmark] against the encroachment of foreign competition, low cost competition.

So I actually think, oddly enough, we've positioned ourselves extremely well.

And you'll see new products coming out and I probably shouldn't tell you the marketplace.

In a number of different segments where we've responded to that, already products are available, ready to launch.

And I think we're going to be well, well placed, Steve, to capture this growth in this marketplace wherever it happens, even if it raised the kind of secular question you're implying in your question.

Thank you.

Thanks, Steve.

Our next question comes from the line of Shannon O'Callaghan with Barclays Capital.

Please proceed with your questions.

Good morning, guys.

Good morning, Shannon.

Hi, on the inventory reduction comment, when you -- you mentioned the gross margin impact.

I mean when you think about that on the segments, can you quantify which segments got hit the hardest by that?

Well, as I think you would probably expect, it's the ones with the steepest volume declines.

So I think it's a direct correlation.

That's not to say that we're not driving improvements in consumer and healthcare, but there's just much more of a need right now in those businesses who have seen the biggest volume reductions to adjust their output plan.

So--

I mean for industrial and transportation all extra, do you have any size of what you think that hurt you by?

No.

I would take -- if at the Company level we said we're about 1.5 points, you could probably take those businesses and say they are probably two points plus.

That's kind of a back of the seat answer, Shannon.

Okay.

Well, what about on the flip side then?

You had kind of the blowout margins in healthcare and consumer and office were, held impressively well, too.

I mean was there anything you discount there in terms of mix or something going forward?

No.

It's -- I think it's fair to say that with the -- our industrial related businesses and electronics hurting as bad, we did have to probably choke off some spending in healthcare and consumer for the good of, for the good of the Company.

Not long, long-term, but at least from a timing standpoint.

Part of the reason consumer's margins improved was just some timing of some of our merchandising programs and so forth.

And we'll have to manage those as the year goes on.

One of the great things about having the portfolio of business you've got, you've got a third of our portfolio is really doing, reasonably well, okay in, this environment.

Really trying to help out the other, the other piece of it.

I think long-term, Shannon, clearly this healthcare business is just a great place to invest.

It just is a great place to invest.

For all sorts of different reasons, growth rates, absence of volatility, and just the overall quality of margins.

We -- our sort of long-term view in the healthcare business is margins that are in the late 20s.

But obviously those kind of margins are going to be, are going to be with much higher growth rates and there will be some transitioning.

It's possible that these margins would ease a little bit, as growth picks up, as we invest more in R&D and we push the product a little harder.

But this is just fundamentally just a great segment, with great possibilities, great growth, great margins, and we are just so glad to have it.

Okay, great.

Thanks, guys.

Thanks, Shannon.

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

Please proceed with your question.

Good morning, guys.

Good morning, John.

Some people are looking at China as kind of the leading indicator of the economic cycle.

And I think there have already been reports of at least domestic consumption turning up for the last couple of months in China.

It sounded like you were still waiting to see it.

You expect it, but it sounded like you hadn't seen it yet.

No, it, it's begun to happen.

I think the fourth quarter, John, was, was I think something of a shock to a lot of people in the way that Boeing fell off.

But no we are seeing -- that's the kind of reports we're getting out of our Chinese folks, that they are seeing that domestic volume picking up.

And of course obviously what they hope is the balance of the year and the balance of the world responds, that they will see that going back to the old ways of export land.

So I think now, it seems that that Chinese stimulus package, John, is, is beginning to get traction and working reasonably well.

Is it your consumer materials, your consumer-related stuff, or is it your infrastructure products that you would have in China?

It's, it's mostly everywhere.

That, that business that we have over there, John, is kind of China for China.

It's not the China for export necessarily.

It's not -- at least it's not how we, we set it up.

So I think when those, when those -- in turn, the economy markets improve, we're just going to ride this along with kind of general GDP-like improvement in the China economy.

Thank you.

Thanks, John.

Thank you, John.

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, everybody, for listening.

Hopefully we answered your questions well and we look forward to talking to you next time.

Thank you, very much, everybody.

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

You may all disconnect, and thank you for participating.