3M (MMM) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M third quarter earnings conference call.

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

Afterwards we'll conduct a question-and-answer session.

(Operator Instructions) As a reminder, this conference is being recorded Thursday, October 28, 2010.

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

Good morning, everyone, and welcome to our third quarter earnings call.

Before we begin, just a quick reminder, on the morning of Tuesday, December 7, we will host our annual outlook meeting at the Grand Hyatt Hotel in New York City.

Those of you that are on our e-mail distribution list should have received an invitation earlier this week.

Please RSVP as soon as you can.

And for those of you not on our list who would wish to go, just drop a note or call and we will take care of you.

Take a moment, if you would, to read the forward-looking statement on slide two.

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

We base these statements on certain assumptions and expectations of future events that are subject to risks 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.

Let us begin today's review.

I will turn the program over to George Buckley.

Please turn to slide three.

Thank you very much, Matt.

Good morning, everybody.

And thank you very much for joining us on our third quarter call.

It was another very strong quarter for 3M as we continue to drive our [goal] plan and overall Q3 sales and earnings were in line with our expectations.

And you can imagine I'm especially pleased with the 11% increase in organic volume against a backdrop of continued economic uncertainty and tougher comps.

Organic volumes are now up 16% through September and we continue to set sales and profit records.

Q3 sales were again a new record for 3M with the strongest growth coming in E&C, our Electro and Communications business, where sales were up 25%, Display & Graphics where sales were up 19%, Industrial & Transportation where they were up 14%, and Consumer & Office which was up an impressive 11%.

And they, for example, exceeded $1 billion in sales for the first time ever in a quarter.

Health Care, Safety & Security are still robust but both had some peculiarities to deal with in the quarter which I will explain in a minute.

We continue to grow across all geographies, once again, reinforcing our international growth strategy.

Sales in emerging markets as a whole were up 25% in the quarter and now exceed 34% of total Company sales.

Asia Pacific grew 28%; Latin America grew 14%; and Canada 13%.

Korea was up 48%; India 39%; Russia 32% and the China region was up 31% with Brazil up 25% as well.

Operating margins remain strong at 23% with all businesses staying at operating margins at 20% or higher.

EPS was $1.53, up 13%, another all-time Q3 record for 3M.

Free cash flow was $1.1 billion with nearly 100% conversion rate.

We also continued our accelerated investments in the future.

We consider these extraordinarily important in solving the puzzle of higher growth rates longer term.

For example, we increased R&D investment by 6% year-on-year, and we supported our brands with increased advertising and merchandising spends of more than 30%.

New business venture investments, which are those investments outside R&D, continue to track at about $100 million additional annual spend year-over-year.

We put more capital work by closing the acquisitions of Arizant and Attenti Holdings, and we acquired a majority stake in Cogent Incorporated, and in early October we also announced the acquisition of Alpha Beta which is expected to close in the first quarter of next year.

I will address those acquisitions in more detail in a few moments.

Overall, the strength of 3M's portfolio was again evident in the third quarter.

Industrial & Transportation, which is the giant of 3M's businesses, where sales rose a huge 14% with broad-based double-digit local currency growth in every single unit led by Renewables Energy division which was up 83% in sales and limited solely by manufacturing capacity which we are adding as fast as we can.

The growth was everywhere in Industrial.

As examples -- energy and advanced materials rose 25%; abrasives was up 18%; automotive OEM was up 17%; and industrial adhesives and tapes, which is our largest business, was up 13%.

As evidence of our success in automotive, Q3 worldwide automotive bills were up 10% while 3M's organic volumes were up 18%.

Year-to-date worldwide automotive bills are up 29% while 3M's organic volumes are up 14%.

Operating income for the sector rose by 14% to $446 million with operating margins at 20.2%.

The remarkable reinvention of this heartland of 3M's business by H.C.

Shin and his team is nothing short of stunning.

Health Care, sales rose there by 1.5% in local currency which is much slower than we've seen in recent quarters.

The most evident impact in the quarter was the reduced H1N1 related demand which lowers year-on-year growth rates by a full 2 percentage points.

You'll recall that H1N1 demand was the highest in the third quarter of last year.

Lower core demand seems to be related to the uncertainty surrounding Obama Care.

You've seen that pattern reflected in pretty much every company reporting so far in the health care space.

Hospital admissions and treatments are down at many U.S.

hospitals so distributors are wary and evidently running down inventories.

As an illustration, I recently read that 50% of Cincinnati hospitals have reported lower admissions.

Higher unemployment and weaker financials seem to be causing people to put off elective procedures and even normal health care as well.

We've no reason to believe that this is anything other than temporary effect and that it will pass.

But clearly there is caution everywhere as we've seen similar slowing in Western Europe.

Better news was that our skin and wound care business was up 7%.

Food safety, absent of divestiture we did last year, was up 12% and dental was up 4%.

Operating income in Health Care was $326 million, with margins just short of 30%.

At our December outlook meeting, we will give you some additional views how health care reform might affect our business.

But the short form is that the impact is likely to be felt most in expensive treatments and advanced devices where we think rationing through tough pricing mechanisms is going to be the highest.

Of course, the impact is just U.S.

based.

While it's clear everyone is going to be affected, we feel that our business, which is mostly consumables and broadly-based internationally, is less likely to be problematic.

Health Care remains a very strong franchise for 3M.

Moving on, local currency sales in Display & Graphics were up 18.4%, another excellent quarter.

Optical systems sales were up 28%, driven by new products for LED flat screen televisions.

In September we saw the beginning of the much talked about and highly anticipated inventory adjustment in the LCD TV industry and we expect it to continue into the fourth quarter.

This is clearly just a market adjustment as our film attachment rates remain as strong as ever.

The imagery correction cost us about $15 million of earnings in the third quarter.

Overall, I'm very pleased with the way our optical business has matured and progressed.

It wasn't that long ago that a hiccup in this business would cause us enormous heartburn.

Yes, today we still feel it and it's always going to be a tough industry that genetically turns on a dime, so to speak, just as it did in September.

But we have a much better understanding of the market dynamics and how to manage them.

We have an absolutely superb management team in place to do it.

The rebuilding that we've done in 3M's traditional non-optical core over the last five years also means that our optical business no longer has to hold the sales and earnings growth wagon more or less alone.

We're so much more diverse in growth now than we once were.

When optical catches a cold, yes, it still means 3M taking a bit of nasty medicine but the Company no longer gets a bout of figurative bubonic plague.

Continuing with Display, commercial graphics continued its strong recovery with impressive double-digit sales growth.

Growth is coming from innovative new products right across and up and down the market spectrum.

We also had positive growth in traffic safety systems, quite an accomplishment really considering there is still no highway funding bill in the United States.

Total Display & Graphics operating income rose 37% to $282 million with margins at 26.4%.

Consumer & Office had a great quarter too, significantly outpacing growth at the retail level and they topped $1 billion in sales for the first time ever.

Joe Harlan and his team drove 11.1% local currency sales growth with a full 9 points of organic growth.

Yes, 9 points and another 2 points from acquisitions.

Office products and the DIY business both achieved double-digit local currency sales growth and whole care and stationery products reached high single-digit growth, too.

As was the case last quarter, we increased advertising and merchandising investments by over 30% year-on-year and that pushes advancing many of our key brands.

Operating income for Consumer & Office was $235 million, with margins at 23%.

Safety, Security & Protection Services sales were down 1.6 in local currency.

Operating profit for SS&PS was $164 million with margins at 20.2%.

This is truly a wonderful sector.

As in Health Care, H1N1 related demand did not repeat in the third quarter of 2010, in this case impacting year-on-year growth for SS&PS by a whopping 10%.

Of course, these products were also at margins strongly accretive to both the Security segment margins and to 3M as a whole.

Consequently, operating margin declined 700 basis points year-on-year which is entirely explained by H1N1 and secondarily by the impact of image corrections in the roofing granules business, both of which we consider to be temporary effects.

Going forward, Safety & Security margins in the fourth quarter will still be negatively affected by these same factors as well as by purchase accounting for Cogent and Attenti.

These lapping impacts are purely an arithmetic issue with nothing fundamental to be concerned about.

Margins will normalize around 23% once the H1N1 comps finish passing through the system sometime in the first half of next year.

In the core of this business, we saw double-digit sales increases in security systems, corrosion protection, building and commercial services and also in occupational health and environmental safety if we exclude the H1N1 affect I mentioned earlier.

Electro & Communications, sales in local currency were up 24% with currency translation adding another 1.5 points on top.

I think it's important to note the continued strengthening of our business servicing the consumer electronics industry.

For example, local currency sales were up 59% in electronic markets materials and 30% in electronic solutions division.

In addition, we saw double-digit local currency sales growth in electrical markets which mainly serves utilities and electrical distribution.

Local currency sales were up slightly in the telecom infrastructure business also.

Electro & Communications drove operating income of $173 million which is up 49% as operating margins expanded 3.6 percentage points up to 22.4%.

So all in all, even with some transient H1N1 and raw material cost impacts, this was another very strong performance across the board for 3M.

I would like to speak now for a moment about acquisitions.

We significantly strengthened our safety and security business by adding Attenti and Cogent to their portfolio.

Cogent brings to 3M a technology platform that we didn't have previously with its finger, palm and iris-based biometric technologies and Attenti positions us well in a segment of law enforcement that we didn't have access to until now, as well as opening opportunities for us in the elder care and other industries.

Both of these businesses' operating markets are growing at greater than 20% annually.

We see Attenti as a completely new high growth platform.

We've long believed that high-value asset tracking is a great future business.

The logical application extensions to military, first responder, elder care, mobile hospital assets, mining safety, animals and even your children, if you desired it, are massive.

In Health Care, the acquisition of Arizant bolsters our infection prevention business by solidifying our position in the growing area of patient safety with its line of patient and body fluid warming systems.

This market is growing at double-digit rates and is likely to accelerate since the focus on body core warming is specifically laid out in the new health care legislation and is seen as a fundamental method to the reduction of cost by control of hospital-acquired infections.

Today this is predominantly a U.S.

business and we intend to leverage 3M's world class international footprint to expand it overseas.

Alpha Beta, in our Industrial segment, perfectly exemplifies our permit strategy in action by adding [B and CT] products to our own line of tape offerings.

Alpha Beta is a world class ultra-low cost tape manufacturer located in the China region.

Over the coming years we expect growth rates to be very high and we'll in-source a lot of currently outsourced tape manufacturing to Alpha Beta.

This is positioned right where the fastest growth is both geographically and segment-wise.

And importantly it establishes a low cost tape manufacturing beachhead in Asia, something we didn't have before.

So this is a great addition to one of our most powerful core businesses.

It's not an overstatement to say that 3M is the greatest adhesives tape manufacturer in the world, so investing here is perfectly logical for us.

On R&D, you all know that for 3M investment in innovation is investment in our future.

In the third quarter, R&D investments were north of 5% of sales and we expect to maintain this level going forward.

As a result of these investments, our new product vitality index is now in the 32% range as we continue to drive innovation right across 3M.

More than a year ago we forecast economic growth would slow in the second half of 2010 in some of our markets.

Some folks disagreed with us thinking that perhaps we were being too conservative.

But I think things have played out largely the way that we anticipated and so the trend is no longer a surprise.

Part of it is purely arithmetic year-over-year comparisons but part is also clearly economic.

Looking ahead, the good news is that we see no signs of any broad scale, broad-based double dip.

Even if it does come, we believe it would be limited in geography, short in duration and relatively mild.

Our (inaudible) growth remains good in those geographies the way you would expect it to be good and it's hard where you would expect it to be hard.

No, we have not seen China slowing and ironically if the renminbi does begin to appreciate, it will provide 3M mostly net positive benefits.

After all we are highly profitable there and a net importer to China.

Excluding Japan, which itself had a 10.5% local currency growth in the quarter, similar positive observations could be made for Asia broadly and for Latin America, the Middle East and Central and Eastern Europe.

The practical reality is that those companies with broad footprints in emerging markets will prosper as long as they remain able to compete with small and fast growing local competitors.

And for that you absolutely must be cost competitive.

For the near-term implications for the United States and Western Europe, Germany apart, are uninspiring.

We expect an extended period of slow recovery in these markets.

The best news is that the recovery in automotive and any positive movement in housing will look like enormous percentage changes.

More broadly, U.S.

factory utilization remains low which implies a long recovery period in commercial construction.

(Inaudible) transients in the industrial distribution channel have died down so they no longer [help.] Unemployment remains, I think, as we all know the key to the puzzle particularly in the United States.

Nothing in the end markets suggest big changes in anything, plus or minus, except the numbers will look arithmetically slower.

Invention and penetration remain the keys to growth for us in these slower markets and that's why the R&D and business development investments that we've spoken about earlier are essential.

Breakthroughs in power distribution, smart grid, solar, environmental and innovation more generally still provide big opportunities.

Differentiation still works and 3M has that in spades.

So gradual geographic realignment of our sales force may be needed to fully take advantage of opportunities in faster growing states and market spaces.

With that, I will now turn the call over to Pat for a review of the third quarter P&L.

Thanks, George, and good morning, everyone.

Please turn to slide number six.

Sales rose 11% in the third quarter which was the fourth consecutive quarter of double-digit sales improvement.

Organic volume rose 10.8% in the quarter.

Our growth was 1.4 times worldwide industrial production as the business continues to expand its size in terms of sales, operating income and economic profit.

We drove 22% organic volumes in Asia Pacific with both consumer electronics and the base business increasing over 20%.

So our strategy around both export oriented business and meeting local demand is working very well.

Organic volumes grew 13% in Latin America, 6% in the U.S., and 4% in Europe.

So no geography was left behind.

Acquisitions added 50 basis points to growth in the quarter and selling prices declined just 20 basis points year-on-year.

Third quarter gross profit dollars grew 9% year-on-year and notably were more than 5% above Q3 2008 levels.

So our strategy to grow the business is resulting in higher gross profits.

Gross margin percent declined 90 basis points with higher raw materials accounting for about one-half of the change.

Material inflation was approximately 2.5% year-on-year.

Sales mix also negatively impacted gross margins in the quarter.

As an example, H1N1 related respirator demand was strong in Q3 of last year and factory utilization levels in the businesses were very high.

Those same factors ran at more normal levels this year.

A lower sales contribution from Health Care coupled with its attractive gross margins also impacted the mix negatively.

Helping to mitigate these factors were savings due to yield improvements, waste reduction, faster line speeds and ongoing productivity driven by our Six Sigma teams around the world.

In the SG&A area, sales and marketing investments rose 18% in the quarter, while administrative and other costs were up just slightly.

So in total, SG&A was up 13%.

We anticipated this in our planning as we mobilized throughout the year to increase both sales coverage and marketing strength particularly in faster growing emerging economies.

In addition, we increased investment in advertising and merchandising by over 30% year-on-year to drive higher sales volume with our customers both now and into the future.

We invested $354 million in research and development in the quarter, up nearly $20 million over last year's third quarter.

Operating income was $1.6 billion, the highest of any third quarter in our history.

And margins were an outstanding 22.9%.

All six reporting segments posted 20% plus margins, the third consecutive quarter that we have accomplished this feat.

Our corporate miscellaneous reporting segment showed a smaller loss this quarter versus the first six months run rate.

This was largely due to lower corporate spending, various compensation-related adjustments and a few other miscellaneous items.

By its nature, profit and loss in this segment can swing a bit from quarter to quarter.

On a September year-to-date basis, the operating loss in corporate miscellaneous was larger than 2009 by $117 million with the difference largely attributable to higher pension expense.

The third quarter tax rate was 26.8%, down about 5 points year-on-year due to lower effective international rates and reflects some of the great progress we had made in reducing our tax rate.

We expect that the full year reported tax rate will be approximately 28.5%.

Earnings were $1.53 per share on a GAAP reported basis, an increase of 13%.

This also was a third quarter record for the Company.

Now let's look at the year-to-date results so please turn to slide number seven.

We are very pleased with how the business has performed thus far in 2010 and are running ahead of our expectations going into the year.

September year-to-date sales were up 17%, nearly all driven by organic volume improvements.

Asia and Latin America had been the stars in terms of geographic performance.

On a business by business basis, growth has been the strongest in the Electro & Communications of 31%, Display & Graphics at 29%, and Industrial & Transportation at 22%.

These three businesses have done an outstanding job at launching new products and taking share in a number of important and growing industries including consumer electronics, automotive OEM, general industrial and renewable energy.

Year-to-date SG&A spending is up 11%.

Investments in sales and marketing are up 14%, a combination of more sales-related feet on the street in growing markets, further investments to strengthen our marketing capability, and as you see on this chart a near 30% increase in advertising and promotion to drive current and long-term growth.

Tight control over G&A remains a top priority for the Company as it helps feed additional investment in sales, marketing and R&D.

On a year on -- year-to-date basis, G&A is up only 5% compared to sales growth of 17%.

So we continue to drive leverage in this area.

Operating income is up 33% year-to-date and operating margins were over 23%.

All businesses earned 20% plus margins through the first nine months of the year.

The reported tax rate through nine months was 28.3%, down from 31.2% in 2009.

Recall that our tax rate was 34% five years ago.

So we were making excellent progress in this area.

We expect that rate to tick up a bit in 2011 which I will talk more about in a moment.

But we remain committed to further long-term reductions in our rate.

Evolving the manufacturing base to lower tax jurisdictions will be critical to making this happen.

Finally, year-to-date net income and earnings per share rose 40% and 36% respectively.

Return on invested capital was a strong 22%.

Please turn to slide eight for a balance sheet and cash flow discussion.

Free cash flow was $1.1 billion in the third quarter and we converted nearly 100% of net income to cash.

This was $466 million less than the third quarter of 2009, driven largely by three factors.

One was pension contributions, as we contributed $241 million more than we did last year.

In addition, the year-on-year difference in cash taxes paid was $111 million.

Finally, working capital changes reduced free cash flow by $175 million to meet the volume demands.

On a year-to-date basis, we generated nearly $3 billion in free cash flow and converted 94% of net income to cash.

Net working capital terms remain steady year-on-year at 5.1 turns.

We had some improvement on the receivable side offset by somewhat higher inventories aligned, of course, again to the higher growth rates.

Acquisition activity has been light in the first three quarters of the year.

But as we have recently announced, and George has mentioned earlier, we will close a number of deals here in the fourth quarter putting to use some of our excess cash.

Through nine months of 2010 we returned more than $1.5 billion to shareholders via a combination of dividends and share repurchases, a 43% increase versus 2009.

With three-quarters of the year behind us let me address our outlook for the year.

Please turn to slide number nine.

We now expect our organic volume growth will come in between 13.5% and 14% for the year versus our prior forecast of 13% to 15%.

We also expect that earnings per share will fall somewhere within the band of $5.70 to $5.74.

This range includes estimated acquisition-related dilution of approximately $0.06 per share related to the recently closed deals which, of course, we had not factored into our July guidance.

On a GAAP reported basis, we expect earnings to finish for the year between $5.59 and $5.63 per share.

We anticipate that operating margins will be approximately 22.5% for the year which also reflects previously mentioned acquisitions.

The full year tax rate is expected to be at or just below 28.5% on a reported basis and average diluted shares outstanding should be in a band of 725 million to 727 million for 2010 in total.

Please turn to slide number ten.

As Matt mentioned, we will be hosting an investor meeting the morning of December 7 in New York.

We will address our detailed 2011 outlook at that meeting but I thought I would give you a preview this morning.

Please wait for the December meeting for some more specifics.

At the moment, we are targeting 2011 sales growth of 11% assuming a couple points of acquisitions in current FX rates.

We are driving the business to deliver 35% incremental margins on organic growth.

Outside of those incrementals, currency should be an additional income tailwind for us, again, reflecting current exchange rates.

We estimate pension expense will be a $0.30 headwind next year.

This assumes that the 4.86% discount rate at the end of the third quarter falls until year end which in our opinion is an unsustainably low level.

Regardless, it is down nearly a point from 5.77% that we used at last year end.

The 2011 expense estimate also assumes U.S.

asset returns of 11% which was our actual performance for the first nine months of the year.

Finally, the $0.30 headwind assumes that we make an additional $700 million contribution to our pension plan, assuming current discount rates and asset return performance levels hold.

But candidly the actual contribution may differ.

If rates of returns move our way, which has happened thus far in October, we would likely contribute much less than this.

We don't have any mandatory funding obligations.

What is most important for us is to be adequately funded at year end and to keep the earnings headwind at a manageable range.

The anticipated expense increase is due to two factors.

One is the amortization of prior period investment returns, namely the 13.6% loss experienced in 2008.

I will remind you though, this was far better than the 30% market decline for that year.

The second factor is the absolute level of interest rates.

Lower rates, of course, increase the present value of liabilities which in turn increase future pension expense.

We also anticipate an $0.08 per share headwind due to a compensation policy change.

As a reminder, prior to 2009 we allowed employees to bank a certain amount of unused vacation.

Effective January 1, 2009, we moved to a use it or lose it approach and employees were given two years to exhaust their previously banked vacation.

This change resulted in an $0.08 per share benefit in our 2010 results which does not repeat itself in 2011.

This item is non-cash, income statement only.

Helping to offset this will be additional productivity gains due to the fact that employees will have less time off in 2011 which will help reign in additional hiring.

Finally, at this early stage we are expecting a 2011 tax rate of 30% or slightly below versus an estimated reported tax rate of 28.5% for 2010.

We have some more work to do before reviewing our final 2011 plan with you in December but this should give you a sense where we are headed.

In summary, I would conclude that our year-to-date results are very much in line with our longer-term strategy.

We are driving faster growth, reinvesting to secure the future of the business and maintaining best-in-class margins and return on capital.

Our balance sheet remains in great shape, so regardless of the shape of the economic recovery we will have a significant funding advantage.

That concludes the formal portion of today's conference call.

So let's begin the Q&A.

(Operator Instructions) One moment, please, while we compile the Q&A roster.

Our first question comes from the line of Robert Cornell of Barclays Capital.

Please proceed.

Hi, everybody.

Good morning, Bob.

I've got a couple of questions.

Display & Graphics had a good quarter but I think you mentioned an inflection point in September.

Maybe you could just go over that a little more.

And you talked about the impact on the fourth quarter, maybe just give us a little visibility there, please?

Obviously, Bob, you see --- about every two years you see these kind of corrections that take place in inventory.

The great news for us is we haven't lost any attachment as far as we can tell which is unlike what happened to us before.

So this has probably just started.

I think it will go through the system.

The impact, potential impact in the fourth quarter that we see, of course, in the end you don't know with this market changes so rapidly.

But the net impact we think might be as much as $70 million in our fourth quarter earnings.

On top line profit, George?

That's on profit, yes.

That's the sort of numeric number there, Bob.

But I think what has really happened so well here is we've got very close to these customers.

They like our innovation.

They've kept us in the product and that is for us the most important thing.

We will live through these things.

As I said, we've had these things come and go before.

This time, of course, it put some pressure on earnings but it's not the kind of ouch that it once would have been.

Got it.

You mentioned the Alpha Beta acquisition, you talked about putting some product back in-house that had been outsourced and the whole push into that adjacency.

What sort of profitability level would Alpha Beta see relative to the 3M average when you have that strategy completed?

Well, at their current operating margins, Bob, they would be dilutive to 3M.

But when you bring them all together, first of all, we don't need a lot of SG&A in that area.

It's not always branded product and we think it's just -- there is huge growth and leverage opportunities in that space.

We were selling into that space and paying higher prices than we will get from Alpha Beta.

So actually I think it will be helpful to us in the long run and obviously it gives us that competitive positioning at the bottom of the marketplace which has always been the place where we've got attacked by growing low cost competition.

This is strategically very important for us.

Not only to provide growth but to provide the bulwark to our higher margin, higher performing tapes, higher up the market permits.

Very important I think, Bob.

Bob, I was going to just add just to build on George's comment.

At the, either the divisional level which -- that's -- our largest division is adhesives and tapes, as George mentioned.

Our objective there is we'll pull this in and through some of the cost savings we get through in-sourcing and the like that the margins in that business should hold where they're currently at at the divisional level.

So the margins at the division level would be the same when you consolidate Alpha Beta and push forward?

Yes, absolutely.

Thanks, Bob.

We have a pretty long call, question queue.

I think we need to move on.

Get back into the queue if you would and if we have time we will pick you up again.

Thanks.

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

Please proceed.

Hi.

Good morning.

Good morning.

It wasn't 100% clear to me why you didn't have a little bit more of a margin pull through in Industrial & Transportation.

I understand there were some raw material headwinds and such.

But given that type of growth rate in that type of business, maybe would have expected a little bit more of an incremental margin.

Can you give us a little bit more detail on that?

First of all, Scott, a 20% margin in the industrial business is a damn good margin.

We're obviously investing in that business, we're investing in new technology, putting new investment in a lot of the emerging markets and so forth.

The reality is the margin in that business will be probably the 21%, 22% range over time, it was a little bit lower this quarter but nothing to be alarmed with.

It's something we've been kind of expecting through time based upon the investments that we are making.

No alarm from our side at all as to where the margins in that business are.

Okay.

Understand.

So the answer is basically investments that you -- now would we think of that as investments some things that you pulled forward just given how strong of a year you had, discretionary spend and such that were pulled forward in the quarter?

Yes, Scott, it would be fair to say and I think if we go back a couple calls that -- and my comment really for the year-to-date is that we are running ahead of where we thought we would be for the year.

We had a number of investments lined up that if conditions warranted effectively we would pull into 2010 here.

So that's kind of -- this is one example of an area that that has occurred.

Okay.

I will get back in the queue.

Thank you.

Thanks, Scott.

Our next question comes from the line of Jeff Sprague of Vertical Research Partners.

Please proceed with your question.

Thank you.

Good morning, gentlemen.

Good morning.

Can we, I guess, I'll make my question and my follow-up around the deals.

First, when you look at, what largely, what you've acquired here, George, I would say they have kind of the feel of being a bit more equipment related companies with the exception of Alpha Beta rather than being kind of material science related companies which is kind of the core strength and bailiwick of 3M.

So just as a matter of philosophically when you look at adjacencies for your businesses, how you manage that, the challenges of that.

Some of these are software companies in a sense.

Just kind of the D&A for the organization to kind of do these type of deals going forward.

Yes.

It's a good question, Jeff.

It really is.

We've long recognized that one of the big growth areas for the future is going to be kind of software and electronics.

In fact, if you look at our strap plans, Jeff, over the last few years you see this kind of creeping in bit by bit.

In fact, maybe not creeping any more, it's galloping.

So we recognize that this is going to be more of the future, a bigger piece of our portfolio in the future.

If you look at some of these high growth spaces, ultimately they are about tracking and decision making that ultimately is connected to electronics and software.

So I think you are right in that area.

These are very high growth areas.

We have some sort of related businesses already, Jeff.

You might remember we got that library equipment business that tracks library books.

This is in a way a lateral extension of that kind of -- instead of tracking a book you're tracking a person or tracking an elder care person.

So they are not that different as you might think if you think of them in that context.

But I think ultimately, Jeff, while we will always have this heartland of material science, I think we will see some movements into these kind of equipment related businesses.

But you aren't going to see us getting into big giant machines like some of our contemporaries have.

This is going to be kind of small, carry it with you type stuff on a much smaller scale than those sorts of things.

But well spotted.

And then I was just wondering as the follow-up, Pat, if you could help us on the 11% you suggested for next year as kind of a baseline given all these deals are closing at different times.

What kind of annualized deal impact is included in that 11%?

Yes.

I guess all I will say right now, because we still have some more work to do between now and December, is we have a couple points of acquisition-related growth in our -- in that 11% number for next year.

A piece of it -- the deals we've just announced and there is a small provision for stuff that obviously is currently in the system.

Thank you.

Thanks, Jeff.

Our next question comes from the line of Steven Winoker of Sanford C.

Bernstein.

Please proceed.

Good morning.

Good morning, Steve.

I know -- Pat, I know you're going to give all the detail in December on 2011.

But on the guidance that you did provide here, should we be adding that to adjusted or GAAP numbers if we are trying to think ahead to whatever that $0.55 or $0.60 looks like it's implied is on top of?

I would come off our GAAP numbers.

When we present our plan we will come off our GAAP numbers.

Okay, great.

And then just without getting more into detail there.

For the quarter, pricing was a 20-basis-point headwind, I think, and at one point 440 basis points of that was in Asia Pacific.

Am I correct in assuming that was mostly in optical and Display & Graphics?

Or were you seeing any more pricing headwinds in any of your other businesses?

No, it really remains in the consumer electronics space, pimarily optical.

Steve, this is Matt.

Just as a reminder.

Generally speaking electronics in total for the Company is about a 1 point impact on price in any given year.

So really, ex-electronics pricing would have been up a little bit for the Company.

Okay.

Then the raw material 2.5%, was that concentrated in any particular segment?

It's --- well, first of all, it's more in the U.S.

than it is international at this point in time, and it is probably more in our industrial related business at this point in time.

It's cutting across most of the businesses but industrial probably has the largest piece of it.

Okay.

Great.

I will pass it on.

Thank you.

Thanks, Steve.

Thanks, Steve.

Our next question comes from the line of Stephen Tusa of JPMorgan.

Please proceed.

Hi, good morning.

Good morning, Steve.

Just to be clear on, I guess, the fourth quarter numbers, I think the performance -- the organic performance this quarter was good, it was about in line with what the comp would have suggested.

But your comp gets a lot tougher in the fourth quarter, and you are still really calling for here maybe just a couple point degradation in the growth rate.

Can you talk about which end markets are getting better from a kind of comp perspective that is going to help you out?

I guess, just where these new products are layering in in the fourth quarter so where we would expect the best organic performance here in the fourth quarter and then one quick follow-up on 2011?

Well, I think the, obviously we talked about some kind of correction in the Display & Graphics business, Steve.

And I think we're still going to be carrying forward headwinds on H1N1.

So they will be the tougher comps.

All of these businesses were growing very, very rapidly last year.

And so it's not going to be easy.

But the forecast from our businesses and our own triangulation suggests you are looking at something like an 8% or so growth rate.

That's what the number looks like, Steve.

It's what the arithmetic shows us.

So far the arithmetic has carried us forward.

I think in the Health Care business, I think it's going to get a little bit easier is my guess.

I think we've got some stuff which is -- looks like it's bettering in that area so I think that probably will get a little bit better.

I don't expect the industrial businesses to do all that much different.

I think we might see just mild betterment in SS&PS as H1N1 was -- the back end of the fourth quarter was easing a little bit.

So I think it's a mixed bag, Steve, but all in all we are comfortable with the projections that we've made.

Steve, and remember, if you back into the number it's in that 8% to 9% range which, of course, if you look at it on a year-over-year basis and you look at what our performance was last year, what you are doing, which we had a 4% growth last year in the fourth quarter, it is really an improvement in performance.

But when you look at where our long-term growth rate wants to be, needs to be, that's consistent with our plan.

Electro & Communications continues to run very strongly and they will have a continued very strong fourth quarter here.

There is no reason, as George said, Industrial will continue to have a double-digit growth here in the fourth quarter.

And surprisingly, even optical being down, it will be up on a year-over-year basis.

It just won't be as good as it has been in the previous couple quarters.

So all in all, it's very solid performance across the board.

Okay.

Then just one follow-up quickly on 2011.

You know -- I'm surprised -- I'm sorry I even gave you guys the 2011 outlook now.

(laughter) Go ahead, Steve.

Well, there's a reason for everything, I guess.

The share count number got bumped up.

I think year-to-date you are looking at something in the 724, 725 range.

What's the fourth quarter ending share count in that number?

Steve, you must be trying to fill out your model, aren't you?

The exit rate is about 731.

So that is a headwind next year as well?

Yes, and what you will see, kind of when we work through it is, we will give you an assumption as to what our share count will be next year when we meet.

We just haven't solidified that answer yet.

Okay.

Thank you for taking my call.

Appreciate it.

Thanks, Steve.

Our next question comes from the line of Terry Darling of Goldman Sachs.

Please proceed.

Thanks.

I hope I don't disappoint you here, Pat, with more 2011.

We do appreciate all that.

If we look at the balance sheet net debt to cap now negative.

Can you, George, talk a little bit about how you are thinking about the pace of acquisitions?

Because you've got plenty of firepower here, but presumably valuations are moving up.

And then maybe dovetailing off the share count perspective, you clearly would have room to do some buyback as well and where is that in your thinking at this point?

I think you can certainly start with the assumption, Terry, that we're going to have an anti-dilution strategy and we have been trying to figure out finally what our position is going to be on more share buybacks.

But I think you are right.

We will probably continue at a similar pace on acquisitions next year.

There is no reason to believe that it will be significantly off where we are today.

Of course, you can't define that exactly at this stage of the game.

But I think there is one school of thought here that says we might advance some of our share buybacks next year a little bit above what we have done in the last couple of years.

So it's very much in the thinking, Terry.

A balanced approach.

We will have a higher CapEx number next year.

Perhaps 30%, maybe even 40% higher than we have had this year.

So you're up in that sort of $1.3 billion, $1.4 billion.

We've got a lot of demand in Asia, a lot of demand in some of these new market spaces in abrasives and in the renewables energy area.

So we're going to have a sort of balanced need, I think.

But I do agree with you.

It probably will leave some room for a little bit more share buyback next year than perhaps we have traditionally done in the last few years.

Okay.

And maybe I'll try to get away with a clarification with this one.

But, Pat, on the 11%, on the 11% revenue growth in 2011, couple points in acquisition, a point on FX, organic implied around 8%, is that fair?

I will give you more, okay.

But you are at least in the right stadium.

You're in the right zone.

Okay, okay.

Let me make this then my real follow-up.

Hey, no, come on, Terry.

(laughter)

35% incrementals next year flow through.

We do, obviously, across the industrial spectrum see rising raw material prices, presumably that means you have to accelerate some of your own price increase activity there.

Just talk about your confidence on managing a tougher raw material environment in 2011 around sustaining that 35% flow through at the segment profit level.

First of all, Terry, it's something we have to do and, of course, our first focus will be on driving productivity and cost reduction programs.

But to the degree that we do need to take out pricing, we will do that.

A follow-up to an earlier comment on raw materials, I think that Steve had, was it is a little more pocketed.

So certain industries will probably have to take some price here.

Realistically, we've probably lagged a little bit, okay, to some price increases that we probably maybe should have done a little bit sooner.

We are currently contemplating some additional pricing.

Some of it is actually happening right now, Terry.

We are on it and I think you're right, I think we are also seeing some easing in some key commodities.

Not huge easing.

I'm not making that prediction.

So a little bit of easing bolstered by some price, that gap should close.

Thanks, Terry.

Thank you.

Our next question comes from the line of Deane Dray of Citigroup.

Please proceed.

Thank you.

Good morning, everyone.

Good morning, Deane.

So it sounds as though the 2011 framework puts you at or above that longer-term 7% to 8% organic revenue growth goal.

I was hoping George could comment on some of these recent moves that move you along that target.

And just with regard to Alpha Beta how that fits the pyramid -- new product introductions, vitality index and now 34% of revenues from emerging markets.

All of this moves you toward this goal.

Should we expect more of the same or are there further initiatives?

I think we like the pathway we are going down, Deane, and you have correctly interpreted pretty much all of what we are doing.

Driving the top line innovation, that's why I mentioned that 32% MPVI number.

That's important.

That will keep on filling the sort of the top of the hopper.

Our pyramid strategy, of which Alpha Beta is part of, helps us bulwark some of the leakage that might come.

That's part and parcel of the puzzle.

You are right about our emphasis on emerging markets, completely correct.

And also you see some of the acquisitions, Deane -- Attenti, Cogent -- in much higher growth spaces than traditionally have been the case for 3M.

We are playing the strings on the fiddle and so far the music is coming out okay.

I'm sure here and there things won't turn out exactly as we hoped.

But I think the last piece of the puzzle, Deane, not to necessarily end on any kind of a negative note, is we've got to start trying to put more of the magic on, I think, our U.S.

business, on our Western European businesses.

But with the kind of capabilities that we have, when you think comparing us, left-right, versus many of our competitors, you wonder how ultimately we are not going to win that battle.

I think it's now just a question of emphasizing those a little bit more and that might give us yet some more lift in due course.

I think you've already --- you've outlined the plan and are dead right on it.

I don't think it's going to change a great deal, Deane.

And just as a follow-up, the comment on Cogent.

I mean, you were already in a passport security system but what else does Cogent add in terms of a security platform for you?

They're primarily border crossing, border security-type applications, so they are high security military, embassies, those sorts of things where you need high security entry.

They are in the classic fingerprint areas and remembering that the only thing that a criminal ever leaves at a crime site is a fingerprint.

It is still very important to local law enforcement.

So that's still important.

But you get up in the level of sophistication, iris scanning, palm scanning, those sorts of things are part and parcel of the secular move toward much more secure border crossing environments with smarter passports, smarter, shall we say, biometric interrogation of people passing the border.

I think this is just a steady move up the technology space for us and into higher growth spaces, Deane.

Thank you.

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

Please proceed with your question.

Thank you.

Good morning.

Good morning, David.

George, this is now your fourth quarter in a row of above market growth.

Do you think you get any credit for that in the market?

And if not, what will it take to get credit for this above-market growth code that you have perhaps cracked here?

I think, David, obviously, we want the same thing that you do.

I think understandably investors want to see a track record.

They are, I'm sure, very pleased with how it's gone so far.

But I think ultimately, I kind of view it another couple of quarters maybe we will get to the tipping point of people's opinion.

But there's still a lot of work to be done before then.

We have to continue to work at this.

Push the stuff that we know.

We know how to do the innovation, we know how to do the customer engagement.

Maybe we aren't getting quite the full credit for it yet, but I think it's no time to be impatient, at least not for us.

We keep on doing what we do well and I have every confidence it will come our way in due course David.

But thank you for the implied help there.

Thank you.

And, Pat, just in 2011, why the higher tax rate and will acquisitions will be dilutive to 2011 EPS?

First of all, acquisitions will be -- when you look at it on a year-over-year basis with the change in guidance that we've had in 2010 here, acquisitions will actually be a little bit accretive for us on a year-over-year basis, slightly.

Tax rate, at this point in time from a planning standpoint, our structural rate is more around 30% right now.

So that's what we will probably put in our plan for next year.

Our long-term goal is 28.5% and keep driving that down.

We were able to -- we were able to pull some things off this year that were more kind of one-time in nature.

And obviously the tax team still has that assignment for next year to keep finding those things.

But it's probably prudent at this point in time to probably plan around a 30% rate.

Thank you very much.

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

Please proceed with your question.

Thanks.

Do you think the correction in the Display marketplace will flush through in the quarter?

Or do you think it could be something that will linger into early 2011?

You never really know.

It depends on how sell through goes in the Christmas season is the answer to that question.

But trying to address it, I think the vast majority of any inventory corrections must be through.

This is an inventory -- sorry, an industry with about six weeks inventory in the channel and their ability to flush it through is very rapid.

You kind of see these things as short and sharp.

They drop fast, they come back fast.

If history has anything to teach us, I think that you will see the first quarter -- once the correction has gone through, you will see the first quarter accompanied by some more rapid growth, a return to rapid growth.

But also traditionally there is -- usually associated with this is some extra pricing pressure as the OEMs try to use that as a means of just sort of bulldozing their way through.

They just basically -- they don't like volumes dropping and price is one of the games that they play, one of the tools that they use to push through.

I think that's the sort of environment that you will see.

And so I think that will ease as the first quarter goes through, maybe the second quarter.

So that's kind of the pattern, short, sharp, wholly fixed in the fourth quarter depending on sell through, probably associated with some pricing pressure in the first half of the year and higher volumes.

That's probably the way this thing is going to pan out.

Thank you.

Thanks, John.

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

Please proceed with your question.

Good morning, this is Lucy Watson on for Laurence today.

Hi, Lucy.

Just wanted to ask, it sounds like about 40 to 50 basis points of the gross margin contraction this quarter was due to unfavorable mix.

And I'm wondering if we should be baking in something around that range of unfavorable mix going forward (multiple speakers)?

Lucy, depending upon what period of time you are thinking of is, a piece of that is raw materials.

We think we're going through kind of the peak of that right now.

That actually should start to decline, we think, a little bit.

Another piece of this, of course, is the mix of the business that we have between Health Care and Safety kind of being down.

The H1N1 piece of this, obviously, will last us for another quarter.

So that impact will still be there.

We do expect Health Care will start to -- will perform better in the fourth quarter than they did in the third quarter.

Maybe a little bit, but I don't think the same degree of reduction, Lucy.

Thank you.

Our next question comes from the line of Ajay Kejriwal from FBR Capital Markets.

Please proceed.

Thank you.

Good morning.

Just wanted to follow up on your comment on D&G and pricing in the first half next year, so some pressure there.

But then would be interested in your thoughts on volume and the trends you are seeing with LED penetration and then expectations for large LCD TVs growth rates going into next year?

Well, I think you will probably see mix shifts as -- when there is any sense of market pressure these manufacturers try fishing in different ponds to see whether they can catch a big tranche of customers.

That's where, I think, the pricing mix will sort of pan out.

You will see probably experiments in lower brightness.

Experiments maybe without films.

Experiments with fewer LEDs and a few things like that.

But I think ultimately -- I mean, in the past those things have not worked well to be completely honest with you and the customer has been unwilling to really, on a consistent basis, accept those.

So I suspect that once the flushing has gone through the channel, it will return to a more normalized basis.

But I think it's -- there's been a fairly sizable gap between the standard CCFL TVs and the LED TVs.

I suspect that gap, that will compress.

And so they will use that, obviously, to drive, I think, volume at the top of the performance pyramid.

A lot of kind of, I suspect, turbulence in the -- even in the fourth quarter but certainly going over into the first quarter until they find the new mix of sales, brightness, sizes, that seems to suit current market conditions.

So some turbulence.

Probably putting pressures on price.

But volume coming back would be my prediction.

We still expect -- flat panel TVs will still be a strong double-digit (multiple speakers) grower.

Very strong growth.

LED, I think, was -- you had a specific question on LED.

We'll probably, the industry probably will run 20%, 25% this year.

That number should be about 2x then probably in 2011, probably approaching 50%.

Obviously that's a favorable mix shift for us.

Good, and just on that 30% increase, add in merchandising spend, clearly investing to push growth here.

Maybe insight into how these expenses track over the next few quarters and then the expectation on the pay back?

Let's say kind of a continuous investment.

So it's not necessarily lumpy.

It's once we obviously get it in the base we will keep going.

It's a little bit -- it adds up somewhat seasonal related, especially in the consumer business.

But our tracking is -- we have a very good tracking mechanism as to what we invest versus are we getting the sales back.

It's different by business.

But it's a long-term -- it's an investment for us both in the developed part of the world.

If you at all are a TV watcher you have seen far more, both TV ads as well as online ads here in the U.S.

But importantly we are also investing a fair amount in the emerging markets.

Now is the time to be investing in our brands in emerging markets.

In some cases that will not pay back immediately.

Some of this is a longer term payback in some of those emerging markets.

Thanks, Ajay.

Thank you.

And our next question is a follow-up question from the line of Stephen Tusa from JPMorgan.

Please proceed with your question.

Thanks for taking my follow-up.

I appreciate it.

Just on the first half of next year you talked about Display & Graphics getting better as you kind of exit the fourth quarter, is there anything going on with the comps that will make growth uneven as you look out to next year for D&G or any of the other businesses?

Stephen, we haven't -- I will be honest with you, I haven't completely [quarterized] next year, okay.

But nothing that comes necessarily to my mind.

You look at -- there still was a little bit of H1N1 rollover into the first half of this year.

So Safety has a little probably tougher comp early in the year versus late in the year.

Other than that I don't see anything that is kind of materially different on a quarter-by-quarter basis.

Steve, I think H1N1 was in the neighborhood of $40 million to $50 million in the first quarter of 2010.

Okay.

Great.

Thanks a lot.

Thanks, Steve.

That concludes the question-and-answer portion of our conference call.

I will now turn the call back over to 3M for some closing comments.

Thanks, everybody, for attending and look forward to seeing you on December 7.

Thanks, everybody.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your line.