3M (MMM) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the 3M second 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, Thursday, July 23, 2009.

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

Thank you, and good morning, everyone.

Joining me on today's call is George Buckley, 3M Chairman, President, and Chief Executive Officer; and Patrick Campbell, 3M's Senior Vice President and Chief Financial Officer.

Today's call will summarize our financial results for the second quarter.

A PowerPoint presentation accompanies today's conference call which you can access on 3M's Investor Relations web site at 3M.com.

All elements of today's call, the slide presentation and the audio replay, will be archived on our web site for an extended period of time.

Please take a moment to read the forward-looking statement on slide 2.

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

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

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

Lastly, please mark your calendars for our next investor meeting which is scheduled for December 8.

We are tentatively planning to have the meeting in New York City.

I'll let you know when the complete details are available.

So let's begin today's review.

Please turn to slide number 3, and I will turn things over to George.

Thank you very much, Matt.

Good morning, everybody, and thank you very much for listening to our second-quarter call.

For 3M the second quarter was a very interesting one.

It marked a course of continued execution of our plan, tight control of our spending, effective management of our restructuring efforts, and sharp focus on cash generation as we simultaneously worked hard to drive sales and market share everywhere that we could.

A few positive sales surprises also got put into the mix.

While we significantly over achieved relative to external expectations, with organic volume still down about 13% year-over-year there is no question that it was another very challenging quarter and particularly so early on.

Compared to the shrinkage of 19.5% in the first quarter, the second quarter was an impressive improvement, and there's no doubt that the second derivative of sales with respect to time certainly appears to be improving.

But as tough as the economy remains, we are, again, encouraged by our ability to operate well in these times and maintain good margins and to generate huge amounts of cash.

We achieved a free cash flow conversion of 160% this quarter which is now 131% year to date.

Overall business conditions in our end markets this quarter were pretty much in line with what we anticipated.

The sales were a little bit stronger than we had expected here and there.

In fact, we achieved sequential sales and profit improvement in all businesses and all regions.

The sequential quarterly sales improvement was 12.4%.

In addition, Health Care and Consumer and Office each drew double-digit year-on-year profit improvements.

Pat will detail the quarter for you in a moment including several factors which helped us this quarter, for example, increased demand for optical films as consumer electronics experienced an uptick, especially LCD TVs, but not only LCD TVs, and the respiratory products used to help prevent the spread of the H1N1 virus.

I must emphasize, though, that our excellent performance was mainly due to the 3M team acting early and vigorously to control those things which were within our power to control.

Our gross margin and inventory improvements show the control of our factories by our teams there was superb, and I'd like to acknowledge publicly those people at 3M who led and participated in this fine effort.

We outlined last quarter the many corrective and control actions that we'd taken on costs and cash starting back in the spring of last year.

And we've continued resolutely on that course.

For example, in the quarter, we reduced staffing levels across the world by another 1,600 people, about 900 of whom came through restructuring, almost all in Europe and Asia, and another 700 via an early retirement program in the U.S.

We absolutely do not take any pleasure in such things, but they are a sad feature of our life in these tough times.

We also continued to streamline our factory operations to suit what we think will be the manufacturing footprint we need long term.

Some of what we see in the shrinking economy is probably not temporary.

We think there are a few end markets that may have been fundamentally reset downwards, and perhaps so for many years.

Housing is the best example of this reset, and automotive will likely see a bite come out of its long-term volume, too, though percentage-wise less than housing.

We, therefore, remain committed to our operating and financial plan which helped us greatly in the second quarter.

And as we expected, the cost reductions from recent restructuring and other actions gained traction in the quarter, and we anticipate those benefits continuing throughout the rest of the year.

Naturally, our strong performance this quarter raises the question about where we are in relation to any economic recovery.

I think in general terms, our business forecasts have so far been reasonably accurate.

We explained on our first quarter call that our modeling suggested the U.S.

economy will bottom somewhere between the end of the second and the end of the third quarter.

And so far, all the evidence that we see continues to support that view.

We're also forecasting that Q1 would be the darkest period of the recession for us.

And so it was.

We also expected that depending on the type of end market some channel restocking would begin to take place late in the second quarter which it did.

We forecast the earliest recovery would come in faster in short development cycle businesses such as electronics which has also begun to happen.

We said that we expected Asia would lead us out of the recession and that Europe as a whole would make the economic turn later than the US.

This is also happening.

And we see Europe still slowing as a whole, but with pockets of slight improvement here and there.

The improvements in the quarter performance can be attributed to several different factors which are, one, slight improvements in end market demand, particularly in consumer electronics.

This is happening more broadly than just LCD TVs, though, it's in monitors and some other segments of electronics, too.

I would only say that we have to be careful to interpret this correctly and not to see what might turn out to be a false dome.

Second, there was a little inventory restocking by some distributors in anticipation of an economic recovery, or perhaps to rectify low service levels after cutting inventory too deep.

You will recall we said we expected the market dynamics to be the same on the way up as they were in the way down and that's what we're seeing in these segments.

Thirdly, share gain as customers have switched to us as a more reliable supplier than their former partners.

The trick here when the economy really gets going is to keep it.

Fourth, demand created by X factors such as H1N1 virus.

These will always happen in a random and unforecastable way.

The challenge here is having capacity flexible enough to ramp up fast, but not so large that it burdens the business during the lulls in demand.

Fifth, and perhaps most importantly, efficiency and productivity improvements produced by tight cost control and restructuring.

You'll see this reflected in our gross margin line which is, frankly, spectacular for such huge falls in volume and testament to how well we are operating our plants in this environment.

Regardless of whether this quarter is truly the first ray of sunrise or whether it is actually a false dawn, because of our early actions and continued discipline, we are well positioned to maintain 3M on this positive trajectory.

I'll expand on our outlook after Pat's comments, and I'll now turn the call over to Pat.

Thanks, George.

And good morning, everyone.

Please turn to slide number 4.

On a GAAP reported basis, earnings were $1.12 per share versus last year's $1.33.

Excluding special items this in this quarter's earnings were $1.20 a share, which was a few cents above our internal plans.

We announced a number of restructuring actions across the businesses and geographies again in the second quarter.

Related pre-tax restructuring charges totaled $116 million in the quarter or about $0.09 per share.

The majority of those costs relates to the permanent reduction of approximately 900 positions spanning many businesses and geographies, although the majority of the reductions were concentrated on the U.S., Western Europe and Japan.

In the U.S., another 700 people accepted the voluntary early retirement option.

We expect a small portion of those employees that accepted the voluntary separation will be replaced in some form.

So on a net-net basis we estimate that total employment levels will drop by approximately 1,400 to 1, 500 due to restructuring actions taken during the second quarter.

Partially offsetting this charge was a pre-tax gain of $15 million or $0.01 per share related to the sale of a New Jersey roofing granule facility.

This gain was recorded in cost of sales within the Safety, Security, and Protection Services business.

You will likely see some additional restructuring actions in the third quarter, but I would anticipate something smaller than those in Q1 or Q2.

Please turn to slide number 5 for a recap of second quarter sales.

While many end markets remained challenging in the second quarter, we did see a few emerging bright spots such as consumer electronics and respiratory protection, as George mentioned earlier.

On a worldwide basis sales declined about 15%.

Organic sales volumes declined 13.5% year-on-year, stronger than our previous expectation of a negative 15% to a negative 20%, and a sizable improvement over the 19.5% decline in Q1.

Second quarter volumes were right in line with recent estimates of worldwide industrial production of a negative 12% to a negative 13%.

It is our belief that many industries are either at or near bottom, that inventory reductions in many end markets should continue to wane in the second half of the year, and that our growth should be equal to or better than industrial production.

Global selling prices rose nearly 2% in the second quarter, and acquisitions added an additional 2.2 percentage points to growth.

And finally, currency impacts reduced second quarter sales by 5.5%.

On a worldwide basis, sales in local currencies declined 9.4% year-on-year including the 2.2% benefit from acquisitions.

Our strongest performer were Health Care at a positive 2.2%, Display and Graphics at a negative 1.4%, and Consumer and Office which was down 2.9%.

Local currency sales declined 10.6% in Safety, Security, and Protection Services, 15.3% in the Industrial and Transportation, and 23.8% in the Electro and Communications.

Turning to the regions, organic volumes declined 5.8% in Asia-Pacific, which was much improved from the Q1 year-on-year volume decline of over 24%.

Volumes were positive in Health Care where the underlying market dynamics are obviously more favorable and Display and Graphics, driven heavily by consumer electronics and more specifically optical films.

European organic volumes declined 18.1%, and the U.S.

was down 14.8%.

Health Care was the strongest performer in both regions, with organic volumes down in the low single-digit range.

Similar to last quarter, volume declines were most severe in the Industrial and Transportation and Electro and Communications, impacted by severe double-digit declines in big markets like automotive, telecom, appliances, and construction among others.

Similar to the first quarter, organic volumes in the combined Latin America/Canada region declined 14%.

Prices rose 2.7% in the U.S., 1.9% in Europe, and 9.4% in the combined Latin America and Canada region.

Of course, much of the increase in Latin America was due to currency as we routinely raised prices there in order to offset the impact of weaker local currencies.

Prices declined by 2.5% in Asia-Pacific, which was all electronics related, so no surprise here.

Now let's review the income statement.

So please turn to slide number 6.

Operational excellence remains top of mind across the Company as evidenced by our 22.6% operating margin in the quarter.

The fact that sales fell 15.1% while operating profits declined only 13.4% should give you an idea about how aggressively we're managing our cost structure during this unprecedented period.

Gross margins were 48.9%, up 70 basis points versus the same period last year.

The decline in organic volumes obviously hurt our results here but this was more than offset by aggressive reductions in our manufacturing cost structure.

In addition, selling prices rose almost 2% which added over a full point to our gross margin year-on-year.

Finally, raw materials turned modestly positive, declining about 2% to 3%.

This was the first year-on-year decline in our raw material index in many quarters.

Second quarter SG&A and R&D spending declined 14% and 16% respectively, about in line with sales.

We began restructuring the Company over one year ago, and the benefits of these actions are really starting to impact our results.

In R&D we continue to support our key larger programs, but overall spending will be impacted by our Companywide cost initiatives such as indirect spending reductions and the vacation policy change.

In the sales and marketing area, advertising and merchandising costs were down year-on-year, but we expect them to rise in the second half of the year in support of our customer programs, including back-to-school and the holiday season.

Operating income was $1.3 billion, down 13.4% versus last year, with, again, an outstanding operating income margin of 22.6%.

Net interest expense increased $15 million, primarily driven by lower yields on cash deposits.

On taxes, things were fairly steady.

Second quarter's rate was 31.2%, up 40 basis points year-on-year.

On a year-to-date basis our rate is 30.8%, down 50 basis points versus the first half of 2008 and right in line with our full year 2009 expectation.

Net income was $843 million, down 14.9%, and just slightly ahead of our own internal expectations.

In this environment, it's not only important to look at results on a year-over-year basis, but it's also important to look at things sequentially.

Please turn to slide number 7.

Sales were up 12.4% or $630 million.

All six businesses posted sequential increases led by Display and Graphics, Industrial and Transportation, Safety and Security Protection Services.

Selling prices were stable, currency was slightly positive, and we did only one small acquisition during the quarter.

So the bulk of our sequential sales increase was good, old organic volume which is where we make the most money.

Gross margins improved three full points versus the first quarter.

Since Q1 was the low water mark in terms of production activity, we obviously had better fixed costs absorption in the second quarter.

Our production levels rose an estimated 15% sequentially which added about two points to gross margin.

And as we expected raw material costs continued to decline during the quarter as we burned off older, higher priced inventory.

RMs boosted the gross margin by approximately 70 basis points when compared to first quarter price levels.

Looking beyond gross profit, SG&A spending was up 4.8% sequentially, but down 150 basis points as a percent of sales as a number of management actions are helping to keep spending under control.

Many of our recent restructuring actions have impacted SG&A, and, of course, stock option expense was lower in the second quarter versus the first, $20 million to be exact.

In addition, recent vacation policy changes had a significant impact on expense levels and will continue to do so for the remainer of this year and into 2010.

Research and development spending was $305 million, down 4.8% sequentially, and down a point relative to sales.

All the actions that I just mentioned, restructuring, vacation, stock options, and the like, apply equally to R&D.

During a recession, all areas of the Company including research and development need to drive operational excellence more aggressively.

Operating income improved 49%, again, primarily driven with volume and the margins improved 5.5 percentage points to 22.5%.

Please turn to slide 8 for a recap of the balance sheet and cash flow for the quarter.

3M's strong operational capability was evident in the quarter with free cash flow of $1.3 billion, up $347 million year-on-year or 38%.

This result was driven by a combination of a lower net working capital, cash taxes, and capital expenditures.

As mentioned earlier, free cash flow conversion was an outstanding 160% for the second quarter, and 131% through the first six months of 2009.

Free cash flow year to date exceeded 2008 levels by over $100 million or 6.2%.

As a result, net debt was $2.8 billion at the end of the second quarter, a reduction of $1.1 billion from March month end levels.

Net working capital declined by nearly $650 million year-on-year with inventory down $574 million and accounts receivable down $487 million.

Inventory turns increased slightly to 4.3, a great result concerning organic volumes were off 13.5%.

Accounts payable declined $415 million versus last year, primarily due to much lower CapEx, raw material, and indirect spending during the quarter.

This was not a surprise to us.

Dividends paid to common shareholders totaled $355 million this quarter, and we continue to hold back on share repurchase activity for 2009 due to the lingering economic uncertainty.

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

That wraps up the balance sheet and cash flow.

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

Please turn to slide number 9.

We are very fortunate to have a very outstanding and stable Health Care business in our portfolio.

As you may have seen, we received recognition this past spring by Fortune Magazine as having the number one ranked business in the medical and other precision equipment category.

Also, for the fourth year in a row our dental business was recognized by the Anaheim Group as the most innovative company in the dental industry.

Recognitions such as these are a testament to the innovative prowess of our highly talented people and the technological strength that we bring to the global health care industry.

Second quarter sales in Health Care were $1.1 billion, up 2.2% in local currency, with acquisitions and positive selling price changes more than offsetting a slight decline in organic volumes.

Currency reduced second quarter sales by 7.1%.

Local currency growth rates were 5% or greater in infection prevention, skin and wound care as well as in the food safety area.

Food safety is a smaller but growing business with tremendous opportunity to leverage multiple 3M technologies to solve customer problems in the food processing arena.

Health information systems drove sales growth of 2% in local currency, and oral care was about flat in the quarter.

In drug delivery systems, local currency sales declined 7% year-on-year, but rose 13% sequentially.

On a geographic basis, all regions posted positive local currency sales growth.

Operating profits rose 11% to $344 million in Q2, and margins topped 32%, driven by positive business mix, along with plenty of heavy lifting by the Health Care team with respect to discretionary spending controls.

Please turn to slide 10 and let us look at the Display and Graphics business.

Sales in this business were $808 million, down 1.4% in local currencies which included over four percentage points of benefit from acquisitions.

Currency impacts reduced sales by 3.4%, so on a total dollar basis sales declined 4.8% year-on-year.

Operating profits rose 9% to $201 million.

Display and Graphics results were definitely a positive for us in the second quarter starting with traffic safety systems.

Sales in this business increased almost 16% in local currencies, a substantial portion of which relates to our December 2008 acquisition of FABRICAUTO, a leading manufacturer of French license plates.

We also drove positive organic local currency sales growth in traffic safety systems as it appears that the summer road construction season has gotten off to a good start.

Government stimulus has been a positive factor in part of Asia, but thus far we have not seen substantial stimulus-driven activity in the U.S.

We expect this to improve as the summer progresses.

Operating profits grew by more than 20% in traffic safety.

Sales and optical systems increased 4% versus last year's second quarter, and were up a hefty 52% sequentially.

Volumes were impacted by two factors.

First and foremost, as we mentioned on the recent conference calls, our teams have been hard at work devising new film solutions to improve the energy efficiency of LCD panels.

In short, our films enable fewer light bulbs in the back panel of an LCD screen.

Those efforts are now bearing fruit, and we have seen nice improvement in film attachment rates as a result.

Second, we saw a significant rise in LCD industry production levels in the second quarter which also boosted our volumes.

Some of this increase was due to replacement of channel inventories which, of course, is difficult to predict going forward, but regardless the industry is healthier than it was one quarter ago.

Selling price pressure is more intense than ever in optical films, therefore, cost reduction remain a day-to-day priority for this team.

They have done a tremendous job in improving production yields, driving operational excellence, running an incredibly productive laboratory and commercializing new product opportunities.

As anticipated, year over year sales were down significantly in our commercial graphics business driven by continued soft advertising spending.

Please turn to slide 11 where I will recap the quarter for our Consumer and Office business.

Once again, our Consumer and Office team did a fine job in the quarter despite substantial near-term headwinds.

Negative consumer sentiment is, of course, impacting retail store traffic, and on the corporate side, lower employment levels are negatively reducing office supply purchases in most companies.

In the face of these challenges, our team delivered operating income of $208 million, up 11% year-on-year on sales of $866 million, resulting in a 24% operating margin.

While sales were down 7.8%, almost five points of that was due to foreign currency translation.

Sales in local currencies were down 2.9%, which includes about a point and a half from acquisitions.

We have recently acquired Futuro, a leading supplier of compression supports and hosiery, and just this month we announced the acquisition of ACE brands from Becton, Dickinson.

These are highly recognizable brands that nicely complement our existing consumer retail health care business, and we're becoming more relevant to the drug store channel.

Looking across the various product lines, sales growth was strongest in consumer health care and including product for the home.

Sales for the do-it-yourselfer and office channels were down year-on-year for the reasons I stated earlier.

However, sales picked up nicely on a sequential basis.

Back-to-school orders typically began to impact us in July.

However, this year we saw those orders begin in late June as retailers attempted to drive more customers to their stores earlier.

We typically increase advertising and merchandising investments in order to drive back-to-school and holiday sales in the second half of the year, and this year will be no different.

So you should expect to the margins decline from Q2 levels.

On a regional basis, sales in local currencies increased at a mid-single-digit rate in Latin America and were down just slightly in both the U.S.

and Asia-Pacific.

Europe posed a challenge again this quarter, with local currency sales declining 13%.

And, of course, we recently announced the appointment of Joe Harlan to lead our Consumer and Office business starting July 1.

I know Joe will do a great job leading this business, following in the footsteps of the very successful career of Dr.

Moe Nozari who retired at the end of the second quarter.

So in summary, despite continued challenging market conditions, the Consumer and Office business delivered great results.

Now please turn to slide 12 where I will discuss details of the Safety, Security, and Protection Services business.

A number of cross currents impacted this business in the second quarter.

First off, the weak industrial economy continued to be a drag on sales in many parts of our Safety, Security, and Protection business such as [frozen] protection, roofing granules, commercial cleaning supplies, and manufacturing-related sales of personal protection equipment.

This was fully expected, and for the most part, sales in these areas generally finish in line with our recent expectations.

At the same time, we saw a tremendous sequential surge in respiratory orders in the second quarter related to the recent outbreak of the H1N1 virus.

Since H1N1 became news early in the quarter, our factories have been running all out in an attempt to meet the surge in demand, and we have backorders extending beyond the end this calendar year.

The last time we encountered a so-called X factor in this business was in 2006 with the SARS virus.

Since then we have expanded our global market leadership by adding more than 40% additional respirator capacity around the world including Korea, the U.S., the United Kingdom, Russia, and China.

And recently we approved an additional investment for an incremental 10% of added capacity to address the anticipated stronger demand through 2009 and into 2010.

It isn't always easy to time these investments, particularly in businesses that encounter such large surges, but in this case we timed them pretty well.

We estimate the sales in the second quarter were boosted by approximately $50 million related to H1N1.

Safety, Security, and Protection sales declined 19% in the second quarter to $794 million.

In local currency terms, sales declined 10.6% and currency impact reduced sales by 7.4%.

Divestitures impacted sales growth by a negative 1% in the quarter.

Operating income was $181 million with a 22.8% margin.

On a business development note, recently the UK government awarded their passport business to a competitor starting in late 2010.

We remain very confident in the future of our passport business, and the growth prospects remaining outstanding.

But needless to say we have more work to do in offsetting the UK business with additional country business.

Please turn to slide number 13 for a look at our largest business, Industrial and Transportation.

Sales in Industrial and Transportation topped $1.7 billion in the second quarter, down 15.3% in local currencies and down 20.7% in dollar terms.

Currency impacts reduced sales were impacted by 5.4%.

The Industrial and Transportation team continues to manage very well through substantial end market declines.

Global auto production was down 25% to 30%.

Therefore, it is no surprise to see that our local currency sales in our automotive business were down 28% on a year-on-year basis.

Sequentially, however, sales did rise 20%.

Versus last year's production levels, the home appliance market is an a double-digit decline, as well, along with industries such as furniture, metal working, and many others.

While things have not gotten sequentially worse in these markets, they haven't gotten substantially better either.

So we continue to manage our costs very carefully, drive cash flow aggressively and work with customers to identify new and innovative solutions to their problems.

There were a few bright spots in Industrial and Transportation in the second quarter, as well, however.

We saw some pickup in consumer electronic-related orders which positively impacted our industrial adhesives and tape business.

Again, we are hopeful that this trend continues, but maintaining caution nonetheless.

Another highlight was our automotive after-market business where local currency sales growth was in the high-single-digits.

This growth was driven primarily through acquisitions as we have made some excellent complementary acquisitions in this space during the past year.

Finally, we also drove high-single-digit local currency sales growth in the newly formed renewable energy business.

Operating income was a strong $329 million in the second quarter, and margins were 19.1%, a strong result considering the degree of the sales decline.

Importantly, margins improved by almost 7 percentage points on the sequential basis, a testament to the aggressive operational excellence and restructuring efforts that this team has executed.

Please turn to slide 14 where I will comment on the performance of our Electro and Communications business.

End market declines have been steepest in this business, particularly in telecom, infrastructure, and commercial construction.

We are still living through a very difficult sales comparisons versus last year.

Sales were $551 million in the quarter, a decline of 27.5% year-on-year.

Sales declined 23.8% in local currency, and the strong dollar reduced sales by another 3.7%.

Local currency declines were broad based across the various business units.

Our business teams have been aggressive in facing many of these headwinds with intense focus on cost reduction and cash flow.

The more interesting story in the Electro and Communications is the sequential change.

Sales improved nearly 15% sequentially, and profits tripled versus the first quarter to $74 million.

Operating margins improved by 8.4 percentage points sequentially finishing the quarter at 13.4%.

This is well below our recent performance and our long-term expectations, but nonetheless, it was an outstanding effort considering the market conditions.

Finally, as a follow-on to Joe Harlan being named the new head of Consumer and Office, we have a new Executive Vice President of Electro and Communications, as well.

Dr.

Joaquin Delgado took the reins effective July 1.

Joaquin was born in Spain and has over 20 years experience with the Company.

A chemist by training, he has experience in a number of 3M businesses as well as our corporate labs.

Joaquin did a stint as managing director of our Korean subsidiary before being appointed to his most recent position of Vice President of electronics markets material division.

Joaquin is a tremendous leader, and I know that the entire Electro and Communications business is in very capable hands.

That wraps up my discussion of the business results.

Now I will turn it back to George, who will update you on our 2009 outlook.

George?

Thank you very much, Pat.

Before we get to your questions, I'd like to address our outlook for the rest of the year.

As a start, I'll take you back to what we said last quarter about how we view economic conditions and how we're managing our business.

End market demand has increased for LCD TVs clearly, particularly the lower energy versions which use 3M's multilayered optical films.

This has resulted in improved business conditions there.

Just for your information, by surface area, demand for these types of films has more than doubled in the last few months, and our margin mix has also improved from the less profitable BEF to DBEF films.

So we are also getting attachment rate as well as end market volume.

H1N1 face mask volume demand is huge and should continue robust throughout the year.

We're adding flexible capacity for this issue, as Pat mentioned, as fast as we can.

We recently authorized $20 million in new capital for this activity.

Automotive after-market, aerospace, renewable energy, and [diaper] tape demand remains good, too.

But apart from these few fireflies, the fact remains that we see no meaningful improvement in most major industries yet, automotive manufacturing, general industrial, and housing, for example.

Slight ones, yes, but too soon to call any victories.

You can see this challenge in our industrial segment results.

In addition, we've seen no sign of improvement yet in Europe as their economies continue to lag the U.S.

and in some cases marginally worsen.

Keynes told us that economic recoveries are only possible and sustainable when there's real improvement in end market demand.

Despite the fact that we all want to believe it, it isn't happening robustly just yet.

It's hard to forecast a precise shape of the recovery and even harder to describe it verbally to you here over the phone.

But our expectations have always been that the profile would comprise a [portion] caused by a sharp falloff in demand due to destocking.

We saw that in the fourth quarter, the first, and part of the second quarter, and flattish but the economic bottom then some fast restocking in [some] industries which we saw in the last part of the second quarter.

This would be followed by a flat spot, as I call it, as end market and wholesale demand comes into equilibrium.

After that the earnings recovery would just gradually follow economic activity upwards in synchronism.

That flat spot, if it comes, may be gained in the late third or the fourth quarter.

So in light of these realities, we're sticking with the fundamentals of our plan, controlling costs, generating cash, and ethically driving sales.

We may well be accused of being conservative, but in our view it's too early and too uncertain to take another path and celebrate some kind of recovery.

The green shoots are certainly there, we admit that.

We just want to make sure that they aren't weeds.

As you recall, we said that because 3M is essentially a short cycle Company the performance of the economy is key to how we view and forecast the balance of the year.

Despite our natural caution, on the positive side, history and experience teach us that 3M will recover considerably faster than companies in longer cycled industries.

What the second quarter brings to life is the underlying strength of the 3M business model.

Its diversity, combined with discipline, provides a platform for cash generation and performance even in the most challenging of conditions.

So we're going to maintain that discipline going forward even as we make plans to selectively increase our growth investments in the second half.

With the second quarter complete, we now believe that organic sales volumes for 2009 will come in somewhat better than we said in the first quarter, and between minus 10% and minus 13%, and that EPS will come in somewhere in the band of $4.10 to $4.30.

In conclusion, we're going to stay focused on cash generation as we work through the downturn, plus strategic investments in growth platforms as the best way to make 3M emerge an even stronger Company than we were even a year ago.

We want to make sure we invest enough in new growth and technology areas as money frees up and not fall into a trap of persistent short-term outlooks.

While it may be too soon to call it recovery, it's not too soon to remind ourselves of the dream of higher growth and to take the steps to make sure it happens.

Again, we are heartened by the power of our business model and by the professionalism and dedication of people around the world and we are more convinced than ever that 3M is a superior and profitable investment for you all.

With that, I'd like to turn the call over to field your questions.

Thank you very much.

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

Our first question comes from David Begleiter with Deutsche Bank.

Please proceed with your question.

Good morning.

Good morning, Dave.

George, what portion of the cost savings and reductions are structural and permanent versus what will come back once demand recovers?

Probably a substantial portion of the people downsizing, David, are.

Obviously, any plant closures and sales of plants like the Belle Mead one are also permanent.

So if I was making an educated guess right now, I would say probably 70% or 80% of the people reductions are permanent and locked in.

And-- on other sort of overall cost reductions, obviously, they will go back up, Dave, as -- as sales flex.

Obviously, in the -- the benefits that we've got from vacation policy adjustments in a couple of years' time, they will pop back.

But, again, they're small enough to be handled.

Pat, have you got any other --?

I would say I think -- it's a good answer.

You know, vacation accrual will pop back over time because that's kind of a one-time benefit we'll get over 2009 and 2010.

We-- I think you're aware we've frozen kind of our merit plan and so forth in 2009.

We'll have to decide what we want to do on a go-forward basis.

To a large degree what we're putting in place are more structural changes.

And I think, as you know Dave, part of the challenge is as business improves, it's how you control the cost structure on the upside.

And I think in the past you've seen as our margins grew from, say, 17% or so back in 2000 up to 22%, 23%, that one of our focus areas is making sure that, I'll call it our overhead costs and so forth doesn't grow as volume returns.

So I think this gives us a good opportunity and a very good leverage factor going forward.

And can you get back to those 22%-plus margins perhaps in 2011 as a recovery occurs?

Well, I guess, Dave, we just ran 22.6% in this quarter, okay?

I guess you can argue that there's a slight benefit of vacation so forth.

Again, with volumes down 13.5% from last year.

So our underlying margin capability is actually better than our previous peaks.

The choice we have to make is the trade-off between growth and margins as we go forward.

Thank you.

The answer to your question is a very clear, yes, David.

Okay.

Thank you very much.

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

Please proceed with your question.

Good morning, guys.

Good morning.

So on the price-cost side of things, you mentioned the sequential benefit in the quarter.

As you look at the costs coming into your pipeline now and outlook for pricing, how do you expect that benefit to flow through the rest of the year?

I would say it ought to remain somewhat constant through the year.

We're very, obviously, aware of what we see, price pressure at the back half of the year.

I would also say, Shannon, that I don't think we've actually reached the low on our material costs yet.

I think we still have a little ways to go there.

So I think the spread that we have here in the second quarter, there's no reason to believe that that won't hold through Q3 and Q4 as we see it right now.

I think, Shannon, in stasis the way we think about this is managing the spread between price and material cost reduction.

Obviously, it's more likely if you have an environment of high commodity inflation, it's an environment that you're more likely to get price and vice-versa.

And so I think in large measure, if pricing got tough, it probably means that -- it probably means that cost reductions got better.

And they kind of run in synchronous, maybe with a little bit of lag and overlap at each end of the transition from one sort of phase to the other.

I think it bodes fairly well for the future on at least that element of our cost structure.

You know, Shannon, I guess to clarify, you have to be careful as you think about this because our price increase, of course, will wane through the year, okay.

Because we're still kind of really reporting, I'll call it, carryover price increases that we've already got in the marketplace.

So as the year progresses, our reported price will continue to go down.

But if you look at it more from an absolute level, our expectation is that we'll hang on to as much of that as possible at the same time that we expect material prices to be a little more favorable.

So the gross margin you saw in this quarter isn't unusual then?

I don't think so.

You know, if you go back and look at our history Q1 was way more the aberration in our historical trend.

Now the good part of it, I think, Shannon to think of it, and back to Dave's comment, is we're able to get to those gross margin levels at a lower volume level now which tells me that fundamentally we've enhanced the overall profitability and margin capability of the Company.

Okay.

Thanks.

Just one more.

George, you mentioned selectively adding to growth investments in the second half of the year.

How much have those been reined in and how much would you like them to come back?

Is it in the form of R&D ticking back up or what do you have in mind?

I don't think they've been reined in so much.

We always at the beginning of the year, Shannon, we have a bucket of things that we can pick from to invest in.

Obviously, you can imagine with a tough economy and murky economy out there, a lot of them we just held.

So it's really a question of not so much what got canceled but what we just slid to the right.

And there's a whole host of those, and some we've actually activated internally just recently.

One on oxidental components, one on sort of heavy industries, shipbuilding and railroads and those sorts of things.

We will sort of accelerate some of our investments in those to date.

But in terms of the question on big R&D programs, as Pat had mentioned earlier in his commentary there really hasn't been any change in that.

You would see some marginal movements in the R&D numbers simply because we followed the same kind of policies in the R&D staffing levels on vacation and on control of incidental and non-core expenses.

We followed the same sort so pattern there that we have everywhere else.

But I think the time may be coming very soon, and kind of Pat hinted at this because of the margin structure, where we can actually release some more money to these investments that will propagate growth.

And we have a relatively long list of these things, Shannon.

The nice thing is that some years ago, we kind of had a lot of money and were short of ideas.

Right now we're a little short of money and we have lots of ideas.

So I think it's going to be fine as the year goes forward.

Yes.

Shannon, I guess the other thing and probably maybe to anticipate a question that will come up is I've said on previous calls that our Health Care margins as an example are probably running a little on the hot side right now.

And realistically we'll probably put a little more investment in that business.

Our long-term margin expectation in that business is more in the high 20s than it is the low 30s.

So over time -- that's not like we're going to invest a huge amount of money.

We'll just gradually ease some spending.

We talked about the investments we're going to make here, an additional respiratory capacity that we did.

And then I would say a little bit -- we'll probably look at some of our emerging market opportunities, places like China and the like and maybe start to accelerate some of the spending.

And then our traditional pattern is that we do increase our spending the back half of the year around our consumer business.

Really on the ad and [merch] side.

Those will probably be the ticket areas that you want to follow.

Okay.

Great.

I'll leave it there.

Thanks, guys.

Thanks.

Our next question comes from the line of Stephen Winoker with Sanford Bernstein.

Please proceed with your question.

Good morning, guys.

Good morning.

Just a follow-up to Shannon's question.

What's your product -- what was your product vitality rate running, the index?

It's running at 27 is what it was at the end of the second quarter.

It happened to be benefited a little bit because of our very strong optical film sales in the second quarter.

There's a number of new products that hit there.

But we're running the mid-to high 20's now.

Okay.

And in terms of the restructuring activities, I know you've talked about equal action across the R&D function.

But if you look at the early retirements and folks sort of walking out the door, has it been in any way disproportional within R&D, or less proportional?

I would say it's probably more proportional.

And when I did indicate that we will be replacing people out of the early retirement program, we're being very cautious as to where we place those people back into the organization.

But R&D, obviously, is at the top of the list there.

So you don't feel like you're losing sort of organizational knowledge in that key function?

No, no.

Not at all.

I think of I remember, Steve, the retirement number from R&D was little over 100.

Of the 700.

And there's also an opportunity to set up sort of a [cherry-picker's] charter.

There are a lot of absolutely superb Ph.D.s doing post-doctoral work right now that we'd like to go out and get.

As Pat had mentioned earlier, one portion of that replacement will come from executing that [cherry picker's] charter.

It is one of the opportunities right now for us to get a lot of really, really talented staff that admittedly can replace some of the experienced staff.

But it has not become a problem for us.

Okay.

Then on supply chain restructuring again, and I know you've talked about how your efforts on that front have changed over time.

In light of this quarter's strong results, how are you thinking about those efforts going forward now?

I guess, Steve, I don't think they're significantly different than we talked last quarter.

There is a couple elements of that strategy.

Part of it was kind of unpicking the hairball that we had.

That continues on, a day-to-day effort.

And I think if you look at our inventory performance and our gross margin improvement, not that I'm going to attribute it to our supply chain moves, but it's an enabler of making that happen.

Some of the longer term investment we're making, we did pull back on a little bit just because the growth rate's not there now.

We pushed those off a little bit in what we call some of our super hub sites.

Our supply chain initiative remains going very well in this quarter.

Part of the restructuring relates to cleaning up part of our supply chains in a few of our businesses.

So we just keep working at it on a quarter-by-quarter basis.

On that super hub and other part of it, can you quantify how much you're planning on spending in that area then?

I mean, versus what you were thinking about historically?

I -- it's not a huge number, Steve.

I would say the reality is we've probably pulled back a couple hundred million dollars of spending, would kind of give you the order of magnitude.

Okay.

Great.

And then last question, on the $700 million that you've been talking about for cost savings for the year, and I know you've talked about temporary versus permanent, et cetera.

But how much of that do you think you realized so far?

Of the -- the 700 people you're talking about?

No, no.

This is the original, when you started talking about your 2009 savings.

Oh, this goes back to your supply chain question?

Yes, well that and all the restructuring.

This was a gross number that you'd put out there before.

Yes.

I guess offhand I don't have a kind of an up-to-date number on this, Steve.

I would say we've probably taken on more restructuring since we did that number.

So the reality is the number's probably -- if I would give you a new updated long-term number, it would probably be higher than that.

Okay.

All right.

Thank you very much.

Okay.

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

Please proceed with your question.

Thank you.

Good morning, everyone.

Good morning, Jeff.

George, your comments about restocking are interesting.

I'm not really hearing that anywhere else yet.

And I just wonder, first, do you actually see customers stocking out in certain places, late in Q1 or early in Q2 driving that or what do you think's really behind it?

Yes, Jeff, Pat here.

I'll try to deal with that kind of first part.

As we talk about destocking it's kind of an interesting concept as to where to -- of course, as na example, in consumer electronics, okay?

Consumer electronics had basically run completely its inventory to the bottom in the first quarter, basically shut down production almost to maybe 25% utilization or so.

So the really is, what's happening is there's a number of industries like LCD that have now starting to ramp back up.

There's a piece of that, that of course is a replenishment of the system in that effectively they were down here in the first quarter altogether.

So to some degree, those industries or segments that basically took drastic actions here in the first quarter around production there's no doubt in Q2 here, okay, one thing that's going on is there's some rebuild of that.

Now, we also honestly believe that there will not be a -- inventories and stocking levels will not go back to where they were when we went into this situation.

So one of the challenges, of course, going forward is we think that the overall demand level including inventory replenishment will be at a lower level than where it was in, say, the 2007-2008 period before the industries started to collapse on us.

I don't think the destocking issue is a serious one, but I think in those industries which have persistent slumps in sales, automotive, housing, I think there's still a little bleed-off.

But I don't want you to think that we're exaggerating that as a feature.

Still it's just kind of bleed, drip-drip stuff.

Certainly I think we're at the point where we're turning more toward either to restocking or an expectation of restocking.

And then just to drill into a couple of businesses, dental, I think you characterized as flat.

But it sounds like maybe that had acquisition benefit in it?

Yes.

How was dental organic?

I would say down five.

The dental portion was a little more favorable than the orthodontic piece.

The orthodontic piece was hit a little harder.

Probably down more of a low-double-digit number.

But the dental, the dental piece was a little bit stronger than that.

It's sort of one of the thing that surprised us, that robustness of our dental business.

I think has pleasantly surprised us.

We expected it to perform well, but it seems to have done better than many of our contemporaries.

And on just on cash deployment, we've kind of tap danced around it a little bit on this call.

But clearly the economy is bad, but also you look to be in pretty good shape from the liquidity and cash standpoint.

Why not go out a little bit farther on the limb on share repurchase or something here?

Is there an inflection point later in the year or early next year where we see something change?

Yes, I guess, Jeff, good question.

And I'll keep taking that question for probably a couple of quarters going here.

We're going to manage our situation cautiously here as we look through the rest of the year.

We've got -- I've got to keep an eye on our pension plan to make sure that the pension plan, where it ends up the calendar year, what kind of funding level we'll need in it.

We are going to put $600 million of stock in it here in the third quarter.

So we'll manage it cautiously, we'll keep an eye on repurchase as an option.

But at this point in time, it's not a -- the --

The great thing, Jeff, which is what you're hinting at is that the improving cash position gives us choices.

We haven't yet made those choices finally.

But really nothing is off the table.

So we'll deal with those appropriately as we -- as Pat and I feel it's timely to do so.

So please don't worry.

I don't follow the logic, though, of putting stock in the pension plan given the liquidity.

What's the thought process there?

Well, we have a long-term need in the plan.

We are continuing to manage our credit rating and the like.

At this point in time, we think we've got some flexibility there.

So we had decided a little earlier on to put stock in the plan.

We think it's a good investment deal for the plan, as well.

That will all hit in Q3?

It will hit in Q3, yes.

Okay.

Thank you.

Thanks, Jeff.

Our next question comes from the line of Deane Dray with FBR Capital Markets.

Please proceed with your question.

Thank you, good morning, everyone.

Good morning, Deane.

Good morning.

I might have missed it, but, George, in your opening remarks, you talked about the -- you hinted at the progression of organic volume through the quarter, April, May, June, how did that look?

Pat can get you the precise numbers.

But April was not that much different than March, Deane.

It was a -- it was still a slow month.

And then the growth accelerated as the quarter went on.

And, obviously, we had a pretty good June.

And it was pretty much as we'd expected.

When we -- I'm not sure if you were involved in these conversations, Deane, but when we were trying to figure out how to do our planning for the year, we kind of made some assumptions about how the channel would clear the excess inventory and when a little bit of refill was going to start.

And we actually calculated it was going to begin happening in June.

And oddly enough it did.

So I'm not sure if that was pure luck or brilliance on the part of the financial people here.

But we got that right.

So I expect that that is going to continue for a little while.

And I mentioned in my remarks, Deane, a sort of flat spot where the -- whatever restocking might be taking place might sort of back off again as people feel they're up to snuff on their inventory levels.

And then it's one of the reasons why Pat and I are a little bit cautious.

We want to see if that pans out in the way that we think it might.

Or if it does, to what -- how serious it might be, how flat it might be or whether it inverts a little bit and you have some kind of mild asymmetric double U.

So it seems to be panning out pretty much as we had forecast so far.

And I expect that maybe toward the end of the third quarter, perhaps it's in the fourth quarter, we might see some moderation of that.

We'll have to see how that goes, Deane.

But that's kind of how I'm thinking this inventory thing and restocking thing happens.

George, that's very helpful.

I think what's interesting is when you talk about the planning process, what distinguishes 3M here is that you've provided earnings guidance, but you've also provided conceptually the milestones that you expect and how to play out.

And surprisingly or not you hit each one of those very nicely.

You've got to be careful, but they might be asking you to do some economic advising in Washington soon.

Actually, Deane, it's a real quick -- a real quick thought.

Joe Harlan said to me on Monday at our management meeting, he said "George, you no longer qualify as an economist.

" I said, "Why is that, Joe?" He said, "Because you forecasted it before it happened."

(laughter) Very funny.

But if we also look at what you all talked about last quarter and Pat commented this as well in terms of the recovery path.

We've talked about some of the restocking and that flat spot.

But last quarter you talked about some of the obstacles being business credit and unemployment.

And how do those two conditions look today versus your recovery path plan?

I think in the unemployment, the number continues to creep up, Deane.

And I hold a thesis -- whether I'm right or not remains yet to be seen.

But I hold a thesis that we won't see any sustainable improvement in the housing market until the rate of unemployment stabilizes.

We can all make forecasts here, but I think that's likely to be in the 11% range and probably either late this year or the first quarter next year.

I think that market is going to be sliding sideways, maybe even marginally getting worse.

Of course, there are going to be repos out there, bargain hunters out there that will drive some volume in certain segments.

But I think the longer term issue is this thing that I call the reset.

I think Jeff [Ingle] called it something like that earlier although referring to other markets.

When I was working for Emerson, we had about 1.3 million or 1.4 million housing starts a year.

We peaked a couple years ago at 2.2 million.

I don't see any reason to believe that housing starts are going to be above 1.5 million in the long run unless some other fundamental lubricant to the economy takes place.

I think automotive -- so that's probably, Jeff, is a year away before we see that kind of movement, I think.

In automotive, I'm a bit more optimistic.

I-- you know, there is a certain sort of replenishment, turnover is necessary in automotive.

And they may see a little bit of a ding, perhaps 10% down.

But I don't expect them to see the kind of real retrenchment, shall we say, that you might see in housing.

So those things, I think, are running to plan.

They'll probably take anywhere between another two quarters and another four quarters to work out.

On general industrial, obviously, in automotive, that will pull through some of the general industrial manufacturing.

That will probably respond a little bit faster in my mind.

And, obviously, we're going to have the pull from consumer electronics for a while which is going to be helpful.

And we'll have some sustainable growth that comes from H1N1.

So I think overall, clearly the landscape is better, Deane.

But I think there's enough stuff out there still to sound a note of caution in our view and just make sure that we don't take our eye off the ball.

In turn, one of the things you always worry about is you get a great quarter like this, and everybody suddenly thinks the problem had passed.

Well, it hasn't.

Because sales are still down 15%, earnings are down 15%.

Even though we performed extraordinarily well this quarter, we need to just keep on doing the same old same old and make sure we do the next quarter and the quarter after until we're all sure that this thing's past us.

George, that's very helpful.

And our take on that is that you've got enough conservative assumptions still within that forecast.

And I know we're past an hour now, but if I could sneak one last question in regarding the business for consumer products.

Have you seen anything different about customer behavior in terms of wanting to trade down from that good, better, best array of products, maybe into more private label, and what might the margin impact be and share changes at this stage?

I have to tell you the truth, Deane.

We haven't seen it.

I know people have talked about it, and I can certainly see the logic behind the thought.

In our case we haven't seen it.

And-- there are some things in life that people want to buy where they get reassurance either from the brand or the historical performance.

And maybe they end up buying less, but I'm sure sure they always buy cheap.

My grandmother used that line "I'm too poor to buy cheap." It hasn't been a factor of what we've seen, Deane.

And I would just remind listeners that in many of these markets where the consumer is buying directly, we have the good, the better, and the best.

So for us it's really just movement backward and forward between these categories.

It's not loss of volume.

And the margins across these segments, Deane, are actually pretty good.

So I'm not anticipating any cataclysmic change in margin if that worry that you expressed visits 3M.

You got anything else you want to add, Pat?

No.

Great thank , thank you

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

Please proceed with your question.

Yes, the back-to-school season here in the U.S.

may be the next test of sort of economic recovery.

You said you had early actually ordering there.

Do you think the retailers actually have enough stock to have up back-to-school sales, or should we at least prepare for that to be flat or weak even with your earlier ordering?

Let's say the retailers are trying to get consumers into the store.

There's a -- obviously, you look at consumer sentiment data and so forth.

And it's a troubling -- still a troubling indicator.

So, obviously, they're trying to pull things forward.

We think there's enough stock -- I guess when we made that comment, John, we're talking about weeks not months, okay.

So it's not a huge shift forward in the activity.

But it is enough to indicate do that we had business in the second quarter versus the third quarter.

So I don't want to mislead you that there was a huge shift in demand, demand pull-ahead.

I think there's -- I think they're trying to, obviously, have adequate stock at least from our product standpoint.

We have adequate inventory with them to pull through.

Now what we have to do, of course, is we have to help them in the back half of the year here with our own promotional work, as well.

Okay.

Thank you.

Our next question comes from the line of Laurence Alexander with Jefferies & Company.

Please proceed with your question.

(inaudible) seeing regionally in terms of end markets in China and Japan, and also, George, you used the expression "false dawns" as being a potential concern late in the year into next year, are there end markets that you view with more skepticism or that you are more wary of a false dawn?

Well, I think in the same way that we outlined earlier, that the markets we expected to respond fastest were the fast inventory turn businesses, short development cycle businesses on the way down.

We expected those guys to come back faster.

I think they're the guys that can turn this stuff on and off a lot faster.

So you have to just wonder in the end can those TV monitor purchases be sustained.

I'm not any kind of prophet of doom here, it's just that I -- having lived with that industry long enough I know they have this superb ability to turn on and shut off almost at a moment's notice.

And I think it's just something that everybody ought to keep in mind that that could happen.

I'm not predicting a "false dawn," I'm just watching to make sure it's not one.

And then with respect to end market trends in Asia?

Market trends in Asia, if you've seen our results were actually very positive relatively speaking.

But, again, we're led by those positive movements in electronics.

Japan still is improving a little, but still seems to be more persistently slow than other parts of Asia.

China is back to positive growth again.

Whether they'll return to the sort of late 20s growth that we had a couple of year ago, we're probably not going to see that, I don't think, this year.

Fundamentally, the market dynamics in China, the demand profile in China is likely to be positive.

And you may have heard us say in the past that our business there is China for China, although some of it, obviously, gets re-exported.

So I think China for us will remain relatively robust.

It will be pulled along or will pull along Taiwan.

Korea's actually doing quite well.

Overall, Asia is doing okay with the exception of possibly of Japan.

So we remain quite positive about it.

Thank you.

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

Please proceed with your question.

Hi, good morning.

Good morning.

Hi, Steve.

Just a question on the capacity you guys put in place just before the downturn here, how is the loading of those plants going?

And should we think about some of this restructuring as part of that process of changing your geographic footprint?

And maybe just a quick follow-on on that one, is there any kind of -- whether it's safety stock or extra cost that you guys were carrying kind of into this downturn because of all that heavy investment you guys put in place before we hit the skids on the economy?

You know, Steve, in my comment around respiratory products, at times I know there's been a fair amount of question about the timing of some of these investments.

But when I look at, and I'll just give you maybe three or four examples.

Part of the investment was for respiratory capacity in a number of different locations, both converting capacity and work in process.

So that's just to out -- ideal for us right now.

I look at our Filtrete filter business as still remaining very, very strong.

Capacity related to that.

And I'm going to say optical film here for a second.

Obviously, there's a lot of worry about some of the investment that we're making in some of the multilayer capacity.

And at the time, we probably were looking at a higher total growth rate there.

But within the last quarter, we've needed every bit of that capacity and then plus more, okay, to actually meet the demand surge.

So that piece of it is going very well.

A number of our Health Care investments that we've made have been very, very solid.

So I'm not going to try and tell you that every one was perfectly right, but the reality is it's played out even in this slower economy to a large degree, the large capacity we put in place.

If you go back, remember that we're looking at specific situations where we were already short of capability.

So it wasn't like we were trying to look at a long-term forecast and then try to anticipate where the market was going to go.

What we were trying to do is really fill a lot of the gaps that we had.

Now, as I previously mentioned, there are some longer-term strategic investments that we're putting in place around super hubs and so forth that were a little bit longer range that we've pulled back on.

So the installed capacity we put in place, though, at least in the second quarter here, we've had a very good utilization rates up.

But part of our restructuring continues to get at some supply chains that still need to be fixed.

There's no doubt that we still have certain businesses that probably need to be shrunk down a little bit.

All the capacity we added were in certain fields and, obviously, we have other businesses and other processes that need to be downsized.

So we'll continue to work on some of those restructuring actions.

But it's played out well for us in the second quarter here.

And I guess that's my point.

I'm not dinging you guys for making the investments that you made.

It's a good long-term plan.

I'm just saying that the question is more around is the restructuring you're doing now, some of that part of this long-term planning that, I guess, you could use the term "accelerated" as opposed to taking away some of the capacity that you could use in an upturn and, therefore, having to add that back.

So I guess that's more along the lines of the question.

Maybe we can --

Steve, let me try to gear -- because first of all not all the restructuring, of course, is in supply chain.

A fair amount of what we've been doing of late is more, I'll call back office, okay, type work.

Specifically in the quarter, as an example, part of the quarter restructuring is a downsizing of our Japanese manufacturing operations.

Right.

We made a decision that Japan's probably not going to return to its prior level of demand, so we needed to ratchet down our capacity in Japan and a few selected businesses here in the U.S.

where we've just consolidated operations, okay.

So there are some supply chain moves that were a part of that, but it's just a small piece of it.

Right.

And then one more quick one.

I mean we've gone about an hour and 15 minutes without a question on D&G, and I just can't let it go.

So I'll ask a very quick question on D&G.

Is what we saw this quarter a dead cat bounce in some of the more commoditized products, or is this something that is kind of a reflection of what some of the newer products that have the more sustainable attach rates can do for you going forward?

I think it's the latter, Steve, it's not a dead cat bounce.

In fact, the -- some of the products that are now launching, of course, we've been sampling to manufacturers for more than a year and pressing the point about the energy efficiency.

And to their credit, and, obviously, you're helped by some sort of time and circumstance, they've responded to that.

And that's what you're seeing now happen, Steve.

I think this is sustainable.

You know, it's the electronics business, and those and those manufactures, again, are very, very able.

They're always going to be looking to find ways to do without something.

I think it's stable for some time.

Who knows, maybe it's one to two years.

In the end, the only way you can stay ahead this game is to continue to innovate, continue to engage with your customers and the challenges that they face, continue to drive out costs, and just make sure that you're the absolute partner that they need in solving the problems that they have, most of which are concerned with improving performance and driving down cost.

It is what it is, in that business.

Tough industry.

Well, it's good to know it's stable.

Thanks a lot.

Thanks a lot, Steve.

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

Please proceed with your question.

Yes, good morning.

Just two quick questions.

On the -- with all the big moves that you made in term of cost cutting throughout the second quarter, can you quantify what the improvement we should be thinking about should be for the third quarter relative to the second?

Third versus second.

I guess is -- oh, I guess probably a couple -- a couple cents, okay.

Is the way I would -- the way I would think of it.

Okay.

Great.

Then the other question with regard to your inventories, they were down sequentially.

Your sales are up noticeably sequentially.

So clearly there was a bit of destocking.

Did that have any negative impact on your margins?

It clearly helped your cash flow, but did it hit your margins where when that destocking comes to an end we may see even further improvement there?

I guess you could -- if I understand your question right, John, it, obviously, could improve to the degree, obviously, our manufacturing rates and so forth improve as a result.

Because you could say, if I understand your question right, because there still a little bit of destocking going.

Once that turns around, obviously, our production rates should improve some more.

And as we looked at our sequential rate as we increased manufacturing utilization you can see that the pop we had on a leverage standpoint.

The other point, John, that's in there is it depends on exactly where it is.

And I don't purport to know how much it is.

But there's likely some material in the supply chain which was produced with high cost materials that as it gets bled off and you fill that with lower cost materials, we may see a little bit of margin help there.

Of course, that's hard to plan and hard to predict.

But it is a positive, John, in the overall trends you see.

Okay.

Great.

Thanks a lot.

Our next question comes from the line of Jason Feldman with UBS.

Please proceed with your question.

Thanks.

The Industrial and Transportation segment was one of kind of the weaker performing segments for the moment.

How much of that lagging do you think is attributable to auto specifically rather than the rest of the business there?

Well, are you saying from a growth rate perspective now, Jason, or what?

Yes, either growth or margins.

Because if I recall the numbers right, local currency growth in automotive is down 28%.

That's our OEM business.

Our AED business actually was favorable for the quarter.

So that's slightly worse than the business as a whole.

So it has, I don't know, probably, maybe four to five points of impact on the big V as a whole maybe.

And, obviously, as I think you've read is that auto production is starting to ramp back up.

So it's one of those things that is just -- will be more of timing almost that that business should see an improvement hopefully as we go to the back half of the year.

Which is why I'm asking, right.

It's the part of the business, I think, that's got cleanest visibility as a discrete portion.

Right.

Okay.

Then also you mentioned that you hadn't hit a low yet on raw material costs.

But are there certain categories of raw materials that are becoming an issue again?

It certainly looks like some commodity categories are beginning to tick up again in price.

Is it just based on where you have inventory or is it just that the price-cost spread remains favorable?

I think, Jason, part of it is, of course, we're on a FIFO accounting basis.

So it takes a while to work through the inventory layer.

So even as prices do move up and we don't have anything that, I guess, I'm alarmed at this point in time.

But as they do move up, it just takes a while to work its way through the system.

We still have, I think, a quarter or so here to kind of play through the bottom of the market.

So it should remain relatively favorable through the end of the year?

I would think so for the near term.

Okay.

Thank you very much.

Jason, to clarify, too, the direct from automotive would be about three point for the total business in the quarter.

Okay.

Thank you, there you go.

Well, thank you very much for listening, ladies and gentlemen.

We do appreciate it very much.

We'll wrap up our call and look forward to talking to you, afterwards those who have more questions.

And we look forward again to talking to you next quarter.

Thank you very much, everyone.

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

You may all disconnect, and thank you for participating.