3M (MMM) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M first-quarter earnings conference call.

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

Afterwards, we will conduct a question-and-answer session.

(Operator Instructions).

As a reminder this conference is being recorded Tuesday, April 26, 2011.

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

Hello, everyone, and welcome to our first-quarter 2011 business review.

With me today are George Buckley, 3M Chairman, President and Chief Executive Officer and David Meline, our recently appointed Senior Vice President of Finance and Chief Financial Officer.

Today we will review our first-quarter results along with an updated outlook for the rest of this year.

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

Today's slide presentation and the audio replay will be archived on our website for an extended period of time.

Take a moment, if you would, to read the forward-looking statements on slide 2.

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.

So let's begin today's review.

I'll turn the program over to George, and please turn to slide number 3.

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

Thanks for joining us today.

From the numbers, you'll clearly see that first quarter was again a very good one for 3M.

We posted over 15% topline growth and if we correct for Japan and H1N1 effects, organic growth was running at about 10.5%.

So we continue to post growth rates which are among the highest in the Company's long history.

We delivered $1.49 EPS in Q1, which was an all-time for the Company in the first quarter and all of this was done at a time when Japan's troubles cost us about $0.03 per share or about 70 bps net of sales growth, all of which was organic, plus of course the additional challenges we saw in the Middle East.

The unrest there cost us a little under $10 million in sales, but nothing significant.

The growth rates were high across the board with E&C, Electro and Communications, leading the way at 21% growth and Industrial Transportation almost equaling at 20% growth.

[INTB] will be about a $10 billion segment for us in 2011 and to see a unit grow this fast in an industrial space is quite remarkable.

Five of our six reporting segments reported double-digit sales increases in the quarter with Display & Graphics also very close to double digits at 9% total growth.

Currency clearly helps us to be sure, but even without that, four of the six reporting segments reported double-digit local currency growth.

Emerging markets were again stellar with sales up 24%, led by developing Asia.

We saw double-digit sales growth in all geographic regions, all geographic regions, including 10.2% in the United States.

We had 47 countries in our portfolio including the United States that reported double-digit sales growth.

And can you believe that Germany's sales growth came in at 24.3% in March, just slightly behind China?

This is, I think, a real testament to the progress that we are making towards being a higher growth company.

We have now had growth in excess of 9% for six consecutive quarters which is a further indication that we are attracting the growth code.

Unlike most other experiments in growth, I think we have proven we can grow multiple businesses at once, not just those that happen to be in naturally high growth spaces.

This is being done by innovation, the innovation of our people.

I think we are also proving that we can grow all the way through the economic cycle.

Companies can acquire growth, yes, and I'm still very much a believer that organic growth is the true test of a company's long-term innate value and capability.

Unless there are more unforeseen geopolitical problems, it seems we will likely see $30 billion in sales in 2011 for the first time in our history.

Our acquisition strategy continues to advance, too.

In the first quarter we closed two sizable deals, Alpha Beta, which is a Taiwanese manufacturer, tape manufacturer and Winterthur Technologies AG, a supplier of precision bonded grinding technologies.

Both will give us new competitive capabilities that will help customers and make us even more competitive.

Other recent acquisitions such as Cogent, Attenti, and Arizant are all progressing very nicely and all ahead of plan.

In the quarter, acquisitions added 3% to our sales growth total.

It wasn't all plain selling in the quarter as pensions, OPEB, purchase accounting, damage in Japan, and raw material prices chipped away a bit at our gross margins, but most of these items we knew about ahead of time.

And they will ease or pass away as the year goes on.

I'll just remind you again quickly here that Optical Systems has an industry normal annual price down environment that is baked into these numbers.

Selling prices turned positive inside the quarter for the Company in total.

Turning to the first-quarter highlights, organic volumes are up 9% even with the adjustments I mentioned earlier.

We've maintained operating margins at 21.6%, with all businesses coming in at over 21%, a phenomenal result in consistency.

Operating income was up 9% on the year to $1.6 billion, another first-quarter record, or up 17% on an underlying basis when we eliminate nonoperational items such as Japan, H1N1, and pensions.

David will address this topic in detail in a few minutes.

The quarter also included the announcement of 3M's 53rd consecutive annual dividend increase.

And in addition, the Board authorized a $7 billion share repurchase in February.

For the quarter our growth share repurchases were $[618] million, a great start.

Again, it was a tremendous start for the year.

Let me quickly take you through some of the performances of our business.

Our largest business, Industrial & Transportation, turned in an absolutely superb quarter with sales growth at 20% and operating income up 17%.

Renewable Energy continued on a roll, with sales up 68%.

Aerospace is up 38% and our core abrasives and industrial (inaudible) and tapes are up 31% and 23%, respectively.

Industrial achieved record quarterly operating income of $516 million with operating margins at 21.1%.

In the acquisitions I mentioned earlier, Alpha Beta and Winterthur were both in this business.

I want here to acknowledge the creative work of one of our dear friends, Tony Stokes, a head of our Automotive Division you all met at our last investment meeting, who sadly passed away 10 days ago of a heart attack.

And he delivered 16% in what became his final quarter.

Tony took a division with relatively low growth and with the force of imagination, inspiration, and innovation had a regular double-digit performer even with these Japanese effects.

Thank you very much, Tony.

We are all going to miss you.

Health Care sales rebounded nicely, up 13% in the quarter with double-digit increases in every geographic region.

Operating income jumped 7% to $369 million with operating margins at 29.4%.

Here, too, acquisitions are important, contributing over 5% to sales.

The Arizant acquisition is going particularly well, outperforming both sales and profit expectations and integration is tracking well ahead of plan.

Consumer & Office achieved sales growth at 10% including a little over 2% from acquisitions.

When you see what is happening in consumer companies around the world and the office environment more broadly, it is really quite remarkable.

Operating income was $215 million.

Importantly, consumer did well in Asia-Pacific and Latin America, two areas of high-growth investment focus for us, for the 31% sales increase in Asia and an 18% increase in Latin America.

So our investments are clearly making a positive impact.

These investments are reflected in COB margins, which are down 2.5 points from last year's high levels.

So while we are seeing some short-term margin erosion, the key for us is to remain committed to invest and drive this business for the longer term.

In addition, COB, like other businesses absorbed from raw materials increases in the quarter, also affecting margins.

On the product front, the new Filtrete water station received the Silver Edison award for innovation in the Consumer Packaged Goods -- Household category.

Sales rose 9% in Display & Graphics with our Commercial Graphics business and newly formed architectural markets leading the way.

In Optical systems, LCD TV demand was softer but smart phones and tablet PC demand remained very robust.

[Learn the] fascination with Optical, I will expand on this in a few minutes.

Overall, the segment posted income of $230 million up 9% with operating margins a strong 24.4%.

One acquisition note, we just announced the acquisition of Original Wraps, Inc., a small company in the commercial graphics space.

This company specializes in the design of personalized graphics for vehicles, which is turning into another big draw opportunity for us.

Safety Security and Protection Services posted a sales increase of 14%, which would've been over 20% were not for H1N1 comps.

Operating income was up 9% to $199 million with operating margins at 21.4%.

We expect this unit to be a sizable beneficiary of increased protective equipment sales when rebuilding in Japan begins in earnest.

Also in the quarter, the head of SS&PS, our good friend, [John LoBey], announced his plans to retire on June 1.

I'm very sad about this since John has done an absolutely superb job building this business and we wish him the very best.

Thank you, John, again.

I know his success at Julie Bushman will continue John's good work.

FYI, Julie was the former head of our occupational health business before (inaudible) John.

Finally, Electro & Communications momentum continued strong in the quarter with sales up 21% and record operating income of $178 million, also at 21%.

Within this segment, our electronics markets materials posted a sixth consecutive quarter of double-digit local curtsy growth.

Needless to say, we are very happy with the performance of this business and we continue to invest in it.

For example, in the quarter, we announced that -- we announced expanded global capacity for Optically Clear Adhesives to support the growth of consumer electronic devices.

And 3M and Quanta formed a new company to manufacture projected capacity touch sensors for the personal computing market.

We showed you some of the exciting new inventions coming your way at our recent investor meeting in St.

Paul.

In addition, EMD, our electrical markets business which serve the power utility and infrastructure markets also posted double-digit gains.

There is lots of excitement in Electro and Communications these days.

So that is a quick run through of our business segments and before I turn the call over to our new CFO, David Meline, let me once again salute the many business contributions of Pat Campbell over the last 10 years or so.

He is an important figure in 3M's history and has been absolutely essential to the transformation of 3M into a faster growing enterprise.

Thank you very much, Pat, and we wish you a long and happy retirement.

And now it is my pleasure to turn the call over to David Meline.

David?

Thanks, George, and good morning, everyone.

I am glad I had a chance to meet many of you at our meeting here in March in St.

Paul and I look forward to meeting more of you in the future.

Meanwhile, thanks for joining today and please turn to chart number 5.

On a GAAP reported basis, first-quarter earnings were $1.49 per share.

This was an all-time record for any first quarter adjusting for the one-time pharma gain in 2007 and a healthy 16% increase over last year's $1.29 per share.

As a reminder, last year's results included a one-time non-cash income tax charge of $84 million or $0.11 a share resulting from Medicare Part D changes in the US Patient Protection Act.

We exceeded our own earnings expectations in the quarter, a good result considering that Japan was an unanticipated headwind.

We estimate that earthquake-related disruption hurt our earnings by approximately $0.03 per share which represents lost business in Japan, plus our best estimate of the impact in other countries.

The earnings impact included lost profit on reduced sales, plus some one-time write-offs of inventory and fixed assets.

We expect additional Japan-related headwind (technical difficulty) in Q2, which are factored into our outlook, of course.

We assume that these headwinds will wane during the second half of 2011, and we could see additional sales opportunities in businesses such as Protective Respirators, Traffic Safety Solutions and Commercial Graphics, to name a few.

George will have more to say about Japan in our forward outlook in just a bit.

Overall, this was a very good quarter for 3M and we are off to a strong start in 2011.

Let me walk you through the details.

Please turn to slide number 6.

If you have followed 3M for a while, you know that our financial objectives call for accelerated sales growth coupled with stable but premium margins and returns on capital.

I think this quarter's results fit that description quite well.

Sales in the quarter rose 15% with 9 points coming from higher organic volumes, 3 points from acquisitions, and another 3 points from favorable currency movements.

Selling prices rose slightly in Q1, but importantly, they improved each month during the quarter as our businesses have stepped up aggressively to help to offset raw material headwinds.

As a reminder to you, price down is a normal part of the business in a few select 3M businesses, Optical being a prime example.

Excluding Optical, selling prices increased nearly 1 percentage point in the quarter.

With respect to organic volumes, we achieved nearly 9% growth in the first quarter, even with some headwinds.

First, Japan -- which hurt sales by just under a point year on year -- the other material headwinds was H1N1.

In last year's first quarter, we estimate H1N1 added approximately $45 million to sales, which did not repeat in 2011.

Adjusting for these factors, organic volumes rose 10.4% in the quarter for a multiple of 1.8 times global IPI.

We continue to be encouraged by the broad-based nature of our growth.

Over the past few years, we have seen steady improvement in the number of businesses that are growing their sales.

This gives us confidence in the robustness of our portfolio versus past periods when growth was limited to one or two of our businesses.

In fact, nearly all of 3M's 40 divisions in nearly 70 countries operated with positive first-quarter sales growth.

We expanded sales in every region of the world in the quarter with Asia-Pacific up 21%, Latin America up 23%, Europe up 13%, and the US and Canada both up 10 percentage points.

And as George mentioned, all six of our business segments expanded sales during the quarter.

Gross margins declined by a point year on year which was largely due to higher raw material inflation.

The good news is our businesses have been raising prices with more to go.

For the full year 2011, selling price increases are expected to offset raw material inflation.

The positive momentum that we saw in Q1 gives me confidence that we are on the right track.

March selling prices were up versus February, February was up versus January, and January was up versus December.

So we are trending in the right direction.

SG&A and R&D rose 16% and 17%, respectively, with increases primarily attributable to continued growth-oriented investment, currency translation, and acquisitions along with higher pension and OPEB expense.

On a percent of sales basis, SG&A and R&D were similar to first-quarter 2010 levels.

Operating income rose 9% to $1.6 billion for the quarter and margins were down about a point to 21.6%.

Underlying first-quarter income growth was much stronger, however, after considering a few transient headwinds.

If we adjust for Japan, H1N1, and pension and OPEB expense headwinds, operating income rose a strong 17% year on year.

The first-quarter tax rate was 28.6%, up 2.5 points year on year excluding the Medicare Part D related tax charge in the first quarter of 2010.

Last year's rate benefited from a corporate reorganization that allowed us to increase ownership in one of our international subsidiaries.

These benefits did not repeat in the first quarter of 2011.

We continue to expect the full year 2011 tax rate of approximately 29.5%.

GAAP net income rose 16% in Q1 or 7% including -- excluding the Medicare Part D tax expense increase in the first quarter of 2010.

Again, adjusting for Japan, H1N1, and pension and OPEB expense, GAAP net income would have grown by 24% year on year.

Please turn to slide number 7.

As I mentioned on the prior slide, operating margins were 21.6% for the quarter, a level that many industrial-based companies can only aspire to.

But margins were 120 basis points below prior year levels and I would like to articulate the primary reasons why.

First, organic growth of nearly 9% boosted first-quarter margins by about 80 basis points.

Raw material inflation, net of selling price increases hurt our operating margins by 90 basis points.

So net net, organic volume growth leverage and installation essentially offset one another in the first quarter.

Business disruptions related to the Japan earthquake hurt operating margins by 40 basis points.

This effect is expected to increase in Q2, but in the second half we expect it will pass.

We believe that our automotive OEM and consumer electronics-related businesses will absorb the lion's share of this impact.

Higher pension in OPEB expense penalized margins by 70 basis points year on year.

This will hurt margins in all quarters of 2011, but using assumed asset returns and current interest rate levels, pension expense is expected to decline in 2012.

Please turn to slide number 8 where I will review the first-quarter cash flow highlights.

Free cash flow was $502 million in the first quarter with cash conversion of 46%.

This was lower than our typical first quarter which averages around 70% cash conversion.

Conversion was lower for three primary reasons.

One, we invested an additional $168 million in working capital in the quarter in support of growth.

In the receivables area, for example, it is not unusual to see receivables rise late in the first quarter only to subsequently fall in April as payments are remitted.

That is precisely what happened this quarter given that March was such a strong sales month.

Taxes also had a negative impact on conversion year on year.

We received an $82 million tax refund in last year's first quarter that did not repeat this year.

Also recall that in the first quarter of 2010, we booked an $84 million tax charge related to changes to Medicare Part D.

This was a non-cash charge which therefore benefited last year's free cash conversion.

Finally, capital expenditures totaled $231 million up 47%, or $74 million year on year.

Our full-year CapEx estimate remains $1.3 billion to $1.4 billion.

Importantly, we are directing more of our capital investments towards international operations and developing markets in particular, and a larger portion of spending is directly aimed at new growth programs.

Despite a lower Q1 conversion, we expect to achieve 100% conversion for the full year 2011.

We spent $680 million on share repurchase in the first quarter, so a nice step up here.

Finally, we invested nearly $0.5 billion in acquisitions, primarily the closing of Winterthur and Alpha Beta.

That is a quick summary of our first-quarter business performance.

At this point I will try the program back to George.

Please turn to slide number 9.

Thank you very much, David.

I would now like to give you some flavor on the outlook for the coming quarters as best as we can see it at this stage.

Let's first speak for a moment about the Japan situation.

Last year, Japan was about 25 -- $2.5 billion in sales for us.

So it was around 9% of our total.

It will interest you to know that Japan had been clocking around 9% of sales growth prior to the earthquake.

While we finished down 3% in organic local currency sales for the month of March, sales were still up 5% in local currency for the first quarter, including showing you both the underlying sales momentum there and the impact of the earthquake.

The human cost to us was blessedly small with no employees or family members losing their lives and only about 10 families losing their homes.

We have done everything possible to help these people, thankfully few of them, without forgetting the scale of the tragedy to them as individuals or to their families.

The earthquake and its tragic aftermath ended up costing us about $27 million in the quarter or $0.03 per share.

We estimate that it will cost us about $140 million for the year or somewhere between $0.10 and $0.13 per share depending on the geographic and market mix of sales.

These are worldwide impact numbers with only about half of the direct impact being in Japan.

Industries, which reflected around the globe, are obviously those where Japan is part of their supply chain.

But on a positive note, the Northeast in Japan ports are now open and there appears to be some basic optimism about our gradual bettering situation in [tech course] Fukushima power plant with cold shutdown of the reactors forecast by year's end.

We have also purchased backup standby power generators for three -- for the three largest plants to ease any concerns about electricity supply.

So logically, we expect the impact of Q2 to be worse than it was in Q1.

So things will probably get a little bit worse due to Japan before they get better.

This is partly because there is a full quarter's effect in Q2 and partly because the component shortages will likely become worse for a while as the quarter unfolds and existing stocks are drawn down.

However, Japan is mobilizing well.

We expect this to be the worst of it.

And the negative effects will gradually abate as we move into the second half of 2011.

We think the Japan impact in Q2 is in the range of $0.07 to $0.08 per share with about half of its total coming from our automotive business.

Q3 might be a small negative, but Q4 should become gradually positive.

So net net, a small impact in the second half of the year.

We will see new compensating demand from reconstruction in telecoms and electricity distribution, construction, and safety apparatus, plus rapid reselling of automotive and distribution pipelines.

And we all know the power that that has to drive results.

We are focusing on organizing to that uplift now.

Not everyone agrees with me, but worries about the Japan's impact on the world economy should also be significantly more muted in H2 second-half as new sources of component supply are found by Japanese companies or alternatively where their competitors take share and fill the same sales gap with their own finished goods.

I think the net of all of this is that the Japan situation while fluid and challenging in parts seems more than absorbable and manageable within our guidance.

So far, we have not included the benefits of any insurance recoveries or receivables in our earnings forecast or of any strong rebuilding recovery in Japan which may begin sometime in the third or fourth quarter and possibly wash over into all of next year.

But we know historically that restocking will begin before a little demand -- a little bit before demand.

So this is another upside to the year.

As we all know, successful insurance claims is a duel between the tenacity of the insured and the terms and conditions of the policies and doggedness of the insurers.

So we've taken a conservative stance.

History suggests, however, that we will be successful to a reasonable degree.

We know that Optical Systems did very well in the first quarter with volumes up nearly 12%.

But also that the TV channel which is now 40% of Optical Systems division sales is still a little full with about three weeks' excess inventory in the channel.

History tells us that retailers and set manufacturers will correct this excess inventory quickly with production cost plus the impact of model change that will take place in the second quarter.

But in contrast, the largest set manufacturer, Samsung, only broke even in this business and Q4 and lost money in the first quarter is forecasting higher sales in the second half.

So the correction may not be that severe.

But for planning purposes, we have allowed some volume contraction from loss of LCD TV attachment, which frequently happens in the ebb and flow of competition and pricing in that channel.

The institutionalized 10% to 15% annual pricedown is already included in our numbers.

I think it is important here to make a point about the increasing strength of 3M's broad portfolio of businesses.

We are no longer the one or two trick pony that we once were.

When we feel confident enough to take up our estimates for the year, even in the face of the scenario I just described, it is clear that Optical does not hold the same weight relative to our other businesses that it once did.

In 2005, Optical was roughly 8% of the Company's sales and 18% of Company profits.

Today, due to growth in so many new areas, it is about 5.7% of our sales and only 7% of our profits.

Still important, it is only about a third of the economic impacts on our 3M than it once was.

It is still volatile and hard to forecast, yes.

But now I think it is time to stop worrying only about Optical.

The balance of Display and Graphics business is also seeing very robust * demand.

Commercial graphics is very strong with sales well north of 20% in the first quarter, and this is nearly always a precursor to bettering economic times.

For the year, even with Japan, we expect that operating margins will be between 21.5% and 23% with the lower end largely a function of potential one-time costs on deals not yet identified or closed.

There's no question that for now overall US manufacturing seems to be weathering the economic storm reasonably well and a weak dollar provides opportunities for export.

I think that 3M's growth and that of the US economy is still going to be strongly led by emerging markets.

But demand for construction equipment is also robust.

On housing, just when you think it is at the bottom, it seems to get worse.

So I think housing prices will still have somewhere to fall this year.

But ultimately at some point, that will attract more buyers.

That will be the start of the housing recovery.

Where in the United States and parts of Western Europe, we know that the bugaboo still remains high unemployment.

Automotive demand remains vibrant with [non-JOM] manufacturers probably able to supply a lot of the lost volume from Japanese sources.

We are also seeing strong sales growth in renewable energy whose growth rates were up 68% in the first quarter.

Abrasives, automotive, and water filtration and electronics generally, particularly in adhesives and high-tech fluids and multi-touch technologies, all grew strongly.

The growth is really broad-based with too many areas of growth to manage specifically and its innovation is driving it.

I don't want to seem like Jeremiah and I mean the prophet here, not the bullfrog, but I can also see a similar set of economic circumstances emerging to those that we saw in mid-2008 with the weak dollar, rapidly increasing oil prices, high commodity prices, and treasury yields, etc.

But on the positive side, liquidity is plentiful and banking is far more sound.

Uncertainty breeds a wide range of forecast and outlooks.

For example the local -- the latest global insight forecasts calls for global IPI to fall significantly from 5.5% to 4.2%.

We have to imagine that a combination of Japan, commodity inflation, the Middle East, persistent high unemployment must take money out of the [working primary] and contribute to somewhat slower growth.

But ultimately, only history will prove some prognosticator correct.

I keep on hoping for a quarter without this level of uncertainty.

But that doesn't seem to be likely for a while.

So we're monitoring the situation very closely and with so many unknowns, we are staying conservative, as you might expect from us.

Our motto is to prepare investors hopefully for the upside, but to prepare mentally for any downside.

And we are certainly more upbeat than some.

As George Bernard Shaw said, the best way to predict the future is to go out and create it.

And that is the business that we're in.

Based on the underlying performance of the Company, on our momentum, on currency impacts, and high levels of new products, when we knit all of this together, we remain much more optimistic than pessimistic about the year.

The net of all of our reasoning is that we expect organic sales growth to accelerate from a range of 5.5% to 7.5% to a new range of 6% to 7.5% including the 1% drag from Japan.

So that is the underlying top end of our range ex Japan up to 8.5%.

So for 2011, in total, with acquisitions priced at a more positive currency outlook, we are expecting double-digit growth in revenues.

Demand has been so strong in some new product areas that we may need to add our fixed capital they are to keep up.

And these are now expected to be in the $6.05 to $6.25 range, even after the Japan impact.

But we make no allowance for the positive upside in insurance recoveries.

Thank you very much everybody for your attention.

We will now be happy to take your questions.

(Operator Instructions).

Laurence Alexander of Jefferies & Company.

(technical difficulties).

I guess two quick questions.

One, what's your total expected raw materials assumption for the year now?

And specifically, when you think about your end markets are you seeing any end markets where you are seeing -- you're seeing, you're starting to see signs of disruption because of higher cost passthroughs.

Laurence, I don't know if you can hear me, this is George, but we've got something wrong with the sort of voice activated audio right now and so we can hear about every third word that you say and while English offers some chance for interpolation it doesn't offer that many for interpolations.

So we are going to try to fix it and hopefully we will be back with you quickly.

So we may ask you to repeat your question please.

I guess to a two-part question, first on raw materials what's your (multiple speakers).

I'll try back.

We can hear you now.

We fixed it, Laurence.

Thank you.

Okay.

I guess the two-part question was one on raw materials, what your inflation assumption is for the year and are you seeing any end markets or regions where you're starting to get concerned about demand disruption because of inflationary cost pressures?

Yes.

On raw materials inflation for the year, we are expecting around 4%, which is what we experienced in the first quarter and we expect that will continue.

In terms of end market impacts, we have not seen the impact.

Even though we have varying levels of inflation going on, we haven't seen that curtailing the strength of demand for us at this time.

So, so far so good, Laurence.

Thanks.

Scott Davis from Morgan Stanley.

Good morning.

George, one of your last comments of the presentation just related to need to add capacity and I want to dig into that a little bit.

If we think about the last up cycle, you did spend a fair amount and added a fair amount of capacity in areas that were tied to the timing.

How do you balance adding additional capacity with some of the other options out there and maybe those options include just A, raising prices or capturing a little bit of margin?

Or B, just putting more emphasis on fixing some of the supply chain issues that you've had on a legacy basis and freeing up some capacity that way.

Is there some granularity you can provide for us there, please?

Well, I think investments in our own growth has always proven to be the best return.

Here we are getting 23% returns or thereabouts on -- and maybe even higher than that incrementally.

So you know to walk away from growth and let somebody else takes a share strategically is probably not a great idea.

So usually when that kind of demand comes along, we are obviously going to ask ourselves the question, is it sustainable?

Is it real?

And if it proves to us that both those questions are answered yes, we will make the investment.

And some of this stuff we are speaking about Scott are -- is in Optically Clear Adhesives and the stuff that is getting put into the tablets and displays, touch-enabled technologies which are just taking off like rockets.

I mean, you've seen the demand reports on some of the electronic guys and we are servicing those people.

And you even saw I think at our meeting here, some of the quite wonderful new technologies that were enabled, completely clear touch -- both side touch, we showed you those kind of gizmos on watches and games that are going to be enabled by this.

So we think it is the right thing to do versus some of the other choices that we have and we think, ultimately, it provides us a stronger company and a better return for our shareholders.

Sure, no I understand.

Any -- George, can you try to ring fence it?

I mean are we talking about $200 million, $300 million additional (multiple speakers) possibly or are we talking more in the range of 1 billion?

No, we're talking -- no, we're talking about -- we're talking about only -- we work on the basis, Scott, there's no surprises.

We always think that's better for our investors and actually for our Board of Directors, even for ourselves.

We are talking about probably only another maybe $50 million or $100 million on top of what David already outlined to you.

That's the kind of order of the scale we're speaking about.

So just pretty material.

Just it -- just it is not some rapid sort of back up the truck kind of scenarios.

Understand and just a quick follow-up.

I mentioned supply-chain improvements just because I haven't heard you talk about it in a while as a driver.

And I know you're five or 6 years into the -- I forget this point (multiple speakers).

We are.

We did everything that we said we were going to do and it still hasn't been enough.

I think we've moved up in our original source of supply target, maybe 2 or 3 points from the sort of the early to the middle 60s.

And so there is just a huge amount still to be had in terms of benefit for the Company, but we are building these plants as fast as we can and the demand is coming almost even faster.

So our ability to catch up -- while the strategy is right, our ability to catch up is limited.

So it has really gone very, very well for us.

So we don't see this as a failure, but rather as a success.

If I could, the other point I would add is what you see this year in 2011 is the first time the Company is now having more than 50% of its capital deployed internationally.

So as we see the recovery in demand, we are adding capacity and where we are adding it is internationally close to where the growth is.

So you are seeing that shift happening as we speak.

Okay.

I'll pass it on.

Thank you.

(multiple speakers).

Yes, understand.

Thank you.

Bob Cornell of Barclays Capital.

You guys made these comments about exceeded joint expectations in the quarter and you took the organic growth up ex Japan to 7% to 8.5%.

Maybe expand on where in fact the quarter did exceed the expectations by business, by geography, whatever?

Yes.

Okay, what I would say is, first of all, we saw geographically a pretty broad base of over performance to our plan.

We saw that happen I would say modestly over plan in the emerging markets.

As you know we've got very strong aspirations for emerging-market growth.

But for me, most encouragingly, we saw good performance in Western Europe in our mature economies, as George mentioned in Japan, before the earthquake hit and also in the US.

So geographically it is quite broad-based.

In terms of sector-wise, we continue obviously to have very good momentum in the Industrial and Electronics space.

They were modestly higher than what we had expected.

And importantly, we saw Health Care for the first quarter after several quarters where they really struggled with growth, we saw what perhaps is an inflection point on their growth rate as well.

Maybe it's a little too early to ask, I mean would you -- I heard a comment about Germany doing especially better and is it -- you think a function of feet on the street there, the labs in those countries, the product vitality?

And at this point is there any way to assess which of the various 3M initiatives are driving that strength?

I don't know that I know the exact answer to that question but we can certainly find it out and give it to you afterwards.

But we are seeing very strong penetration with the new creativity we put into Automotive, we are seeing strong growth in those areas.

Obviously the things that we are providing for general and industrial production is also benefiting the -- there was good growth in Dental.

It was almost I think in fact toward the end of the quarter, Bob, also listing telecoms.

It really has been right across the board and David is right.

You know we tend to be optimistic about our ability to create growth.

We tend to be more pessimistic about the ability of Western Europe and Europe -- and the United States to create jobs.

But they were very, very strong this time, and we're hoping that that means it wasn't a flash in the pan, but it means we've actually made some -- turned some real corner on those things.

So it is just across the board.

Thanks.

Again, on Japan you guys have put out some number here that -- it looks fairly specific given the magnitude of the problems there.

I mean, how have you been able to dig down and be this specific you think with regard to the impact both in sales and earnings over the next three, six months, whatever?

Well, the [fault] in Japan led the initiative.

You know there's quite wonderful, sometimes unhelpful, but quite wonderful metric system that we have here.

So they took it from Japan, ran down all of the threads of the various businesses, how they run into different countries, the various supply chains, the kind of knock on inventory type of analysis that you would imagine.

And this is the best number that we could come up with.

Now we are not going to sort of -- we are not going to bet our pensions on the absolute accuracy of this number.

But you can well imagine we thought it was -- instead of sort of doing some hand waving and giving you some foo-foo dust, we said we want to try our level best to give you a size of it and make sure it's bigger than a cup and smaller than a bushel basket or smaller than a bushel basket or bigger than a container.

So that's what we tried to do.

I think ultimately the number will be wrong to some degree or another.

And I'm hoping that we've been pessimistic in the overall impact that this has.

Because I do think there's some self-correcting influences going on in other businesses around the world.

I mean, both in Japan nearly all suppliers have, they don't single source their supplies.

So they may have to do some requalification as we've done, but there will be sort of things that fill the gaps.

So ultimately I'm hoping we turn out to be a bit pessimistic on this, a bit conservative.

Fine.

Final question for me.

Did you exit the first quarter with a price cost parity or are you still on the ramp towards price cost parity?

Well, as you saw, we exited the quarter with point one positive price which is the first positive price we've seen for I think six quarters.

And in March, we were at 0.5 point.

So as I said earlier, we were ramping up which, obviously, to get to parity for the calendar year, we are going to need to continue to ramp from there and we see that happening across the businesses and around the world.

Again, thanks.

(Operator Instructions).

Steven Winoker.

Sanford Bernstein.

Good morning.

So let me just keep this to the two.

The first one is on that 48% gross margin number and you mentioned 4% raw is up.

You mentioned the 1% or 90 basis point impact negative on price raw, so that to me implies about 310 basis points of positive pricing including optical and the quarter.

Am I thinking about that number the right way?

And if so, can you talk a little bit on pricing, particularly maybe as it affects some of the units like consumer and office?

How are you managing to drive that pricing with regard to -- that is a separate impact from mix, I take it?

And are you seeing consumers trading down?

Sort of could you talk if you could just expand on the pricing dynamics to give us a sense and comfort level that you are going to be able to continue to offset raws during the year?

Yes, and I guess as you might guess we have a variety of situations in terms of the price patterns across our businesses and across the world.

Certainly, first of all, what we see is that where we have the most significant cost pressure is in businesses including Industrial.

And so what they have been doing is they actually went in and in the first quarter implemented price changes; and now as we see continued raw material pressure, we are expecting to have some more in the second quarter.

Other businesses, which have a pricing cycle that might be tied to of for example an annual pricing round such as in areas like Consumer and Health Care, we haven't yet seen the full impact of price changes.

And that is a process that is going on in a number of cases, either as we speak or going to take place in the future.

But generally, 3M enjoys every strong position as a price leader in many other markets that we participate in.

So we typically have very good pricing capability more so than many of our competitors in a particular space.

And we don't view this task as being something that we won't be able to accomplish.

There's another thing behind the scene, Steve, and that is the higher the rate of new products, the more ability we have to size that price.

Because price is, any calculations of price, the better pricing on new products is not included.

Secondly, you can imagine, we also have behind-the-scenes very, very strong and powerful, relentless operational focus on driving out costs.

So there's a -- the first thing we do when we see the source of price increases coming is what can we substitute?

What can we requalify, where can we go with resourcing or substitution?

So that takes place.

We have yield issues that we constantly are driving at, do using our 6 Sigma capabilities and the plants to drive out cost.

So it is not only about price.

We don't sit back and let the prices come back and just say, can we overcome it with price?

Because oddly enough, this is a chance to become more competitive.

If you can wipe the cost, the underlying costs, you don't need to chase as much price.

And in some margins, of course, you can't even get it, but what it ultimately does it just makes you more competitive.

So there's all this kind of activity, a sea of activity behind the scenes that helps us chisel away at this.

So maybe the follow-up, if you can dive into the Consumer and Office business case of the quarter then, you said that some of the pricing hadn't come through there.

I mean, but still we are seeing OI down despite volumes up and I know that there are a lot of dynamics but maybe you could just use that as an example in what you are describing.

I will get Matt to call you back with the details, but you've got the cost of [tachy fires] and polypropylene, which are oil derivatives.

Polypropylene is used in most of the sort of the Scotch Brite and also in our respirators, all sorts of products.

Pricing on polypropylene obviously is part and parcel of the prices on oil.

Price of paper, of course, is another issue in Consumer and Office.

And price of plastics more generally which they sell a lot.

So that is what you see.

And on top of that as we said in the notes to the call, we have been investing a lot of money in [growing integration].

This is a real big opportunity for us for the future.

It is going to cost us some money, for now.

I mean, sales sort of speak you have got to speculate to accumulate and we are -- we see this massive opportunity in Latin America and Asia and are pumping more money into those areas.

Okay, great.

Thanks.

Happy to figure the details later if you want.

Jeff Sprague of Vertical Research Partners.

Thank you.

Good morning, everyone.

For David or George but, David, in your preamble, you kind of mentioned that classic balance between growth and margin at 3M and the R&D numbers are obviously directly a parent in the P&L.

But wondering if there is anything else that kind of stands out in the margins in the quarter in terms of marketing other product development actions or things like that, that you perhaps took an opportunity in the quarter, given what was going on in the top line?

Well if you look at R&D and SG&A, what you would have observed sequentially is that the absolute spend level is roughly comparable to Q4; and what I would infer from that is the fact we said that we had a number of heavy investment programs that we were undertaking in 2010 and those are now in the base.

So what you would expect or what you should expect is that we wouldn't see the absolute spend go down, but now we are running with those businesses in our base of business and they are starting to pay off.

We are starting to see growth from those incremental investments.

They are not fully delivering the kinds of income and margin that we expect.

But it is the kind of thing that we have to stay with.

So what I would take from it is that the investment plan that we put in place are continuing and we are starting to see the kinds of initial indications that that is going to support our growth and we can still deliver the margins that we aspire to.

And if we could perhaps take that and just drill it into a business and perhaps Health Care.

You mentioned that growth is finally showing some signs of life.

The margins back down into the high 20s.

Again, using that business as an example, is that where the margins in Health Care need to be to drive satisfactory growth in that business?

Do margins actually even want to kind of go lower as you are pushing growth?

Obviously there is some deal impact in there also, but (multiple speakers) that?

Yes.

Well, we been pretty consistent in indicating that margins in the high 20s for Health Care is the right kind of place for the Company to be.

That reflects the fact that we are investing in the business for new products and new innovation to grow.

And we think that that can continue.

As I mentioned, we saw an inflection in the growth for the first time in some time.

Is that a trend?

Well, actually not.

It's one quarter, right?

But we think we are moving in the right direction on that.

And just a quick follow-up, if I could?

You mentioned the international investment.

But, given the tight capacity situation [perceives] which you are, I guess it is fair to say chasing to some degree, although in a good way, to what extent have exports ramped up and to what extent are you kind of leveraging weak dollar?

And thanks, I'll pass it on.

Well, I think it's almost opportunistic.

We were doing it when there was a strong dollar.

So it's -- we're not ramping it up because of that.

And I think ultimately that that will reverse itself.

So, but the strategy to go to the market sort of growing fast regardless of the exchange rate is clearly there.

We will capitalize on some benefit washes into our P&L account in the short term, but it won't alter our strategy one bit.

It is where the growth is.

It's where the opportunities lie.

Of course we're hoping, we are hoping as we were just saying, that Health Care is now back on a little stronger track.

We are hoping the United States perhaps is beginning to yield to pressure, the innovation pressure.

And we don't see ourselves -- you know, when you think about all of the currencies that are involved just across the world it's almost sort of self leveling.

Some are gaining on us, some are weakening against us, so I don't think we are doing that or even getting that just because of pricing.

That would be more a case in capital equipment is what I think.

Great.

Thank you very much.

Thanks.

Deane Dray of Citi.

Good morning.

I was hoping to get some more color on the Automotive exposure for 3M.

Based on our estimates it is around 11% of total revenues.

But it's got a nice split between OE and aftermarket, almost evenly.

But what are you baking in for production?

You called out Japan's impact for Auto, but this is -- it has other global implications.

What are you baking in over the near term on these production disruptions?

What we are assuming is that in Japan, in Q2, that production will be down about 50%.

So that obviously impacts us in Japan and there is also some knockoff -- knock on effects externally.

The data that we refer to those commonly is CFM, if you are familiar with them as kind of a leading indicator or economist in the auto space.

And what, in terms of the ripple effect, I mean there's some level loading going on where other productions should benefit.

Have you factored that in as well?

No, we have not.

So we don't --.

We have the best visibility on the direct impact with the Japanese suppliers and we have not factored in sort of the secondary effect of potential market share gains, which I think you see on a delayed basis because if, for example, the Americans or the Germans are gaining share, they can draw on their inventories.

So you wouldn't expect to see an impact of that until you get out of the second quarter into the third and fourth.

Great and then just last one for me would be related to M&A.

And it is clear that 3M has the balance sheet capacity for more transactions.

I am interested in hearing any commentary about the capacity on deal integration.

Is there --?

Could there be any bottlenecks within the organization that have multiple integrations going on simultaneously?

And are there any pinch points there or you feel very comfortable with the ability to add more deals over the near term?

No, it seems to work out okay.

Obviously it is a big company and while we do a lot of acquisitions they are spread run across the Company.

So it tends to be different people doing the integration.

There may be here and there some pinch points in finance and IT that you get some of the same people having to deal with these issues; but it does not seem to have been an impediment to us so far.

And the biggest acquisition we have ever done which was the Aearo acquisition has run like absolutely clockwork.

So I think we continue to get better at them.

I think we continue to be more realistic about forecasting about pricing and I think we've done a pretty good job of executing deals recently without too many times overpaying for this.

So I'm pretty pleased with the way it is going so far.

And we do have a lot of capacity and there's stuff down the pipeline, as you can well imagine.

But it is all sort of front and central, bolt-ons, stuff in the core or near to the core that you would expect of 3M.

And while we always hope for something more significant, we tend to be pretty balanced in our attitudes towards risk and not wanting to do something that might in some way damage the Company.

Great, thank you and I like that Three Dog Night reference, too.

Thanks, Deane.

David Begleiter of Deutsche Bank.

George, in Optical given the pricedown and lower attachment rates, can you still grow earnings in this business in 2011?

My guess is that will be about flat.

I mean, a point up, a point down, that kind of spread.

So I think for now probably a flat income stream is about the best we could probably hope for.

Maybe not the best, but that's probably most likely what we could hope for.

And would you expect resumed growth next year in this business?

Well, you always hope for those sorts of things.

You know, it is a constant battle of bringing more for less to the end customer, and some of these end customers are pretty tough.

They've got their own set of issues that they are wrestling with.

But this has been a remarkable business in many ways, Dave, and you have to give great testament to the creativity of these people who -- when you think about what it is like in a $2 billion business to take a 12% price down year, after year, after year, three years in, that means $400 million coming out of the cost.

It is just vast.

And I think it's a testament to the capability of the people at 3M.

And I really mean this, this is not some sort of slup off thing.

These guys have done absolutely marvelous and I imagine that they will continue to do the same, Dave, and it is where I think ultimately the capability of a company like 3M with its scientific capability, its magnificent world-class manufacturing, will ultimately be the last man standing and many of the smaller competitors that don't have this kind of capability that can only sell on price, that they can only sell on low margin, will ultimately, will ultimately win that battle -- we will win that battle.

I'll bet on 3M.

Thank you very much.

Thanks.

Ajay Kejriwal of FBR Capital Markets.

Thank you.

Good morning.

So on display graphics, good to see the nice performance and this is without any sizable boost from Optical.

Used to be that when Optical sneezed, the segment caught a cold.

So it looks like the other businesses are kind of picking up the slack here.

So maybe talk about what you are seeing in commercial graphics?

What is driving the growth?

Looks like very nice double digit in the quarter.

So talk about the initiatives and what you are seeing in end market spending there?

It's a number of different things.

We are obviously seeing great growth in the core of that business.

What we have done is to roll out over the last few years, Bob and his guys have rolled out a range of new products at more attractive pricing, but good, but good margins.

So we have been able to appeal to a wider swath of the marketplace.

We have got some nice little fledgling activities in various parts of that in projectors and some stuff we're doing for fast food retail that, if it works well, could become an absolute blockbuster.

But I'm not at liberty to tell you too much about that right now.

So there is a lot of great undercurrent, ground swell, shall we say of initiatives in that business.

Of course let's not sort of -- let's not sidestep the wonderful presence in the market that our traffic safety business has.

We are the most confident, the most able, the most competitive company in this space.

The most innovative, our signs are the best, they last longer.

Yes here and there, it may be cost a little bit more, but we are the kings of this particular castle.

And so this is a great segment although over the years it has been buffeted around by Optical.

It doesn't mean that the core, the base of this business is not great.

And that is what you are seeing.

Good.

And then just one more.

On your guidance, the 4% to 6% sales contribution from acquisitions, what is the earnings accretion that is implied this year?

And then what do you expect for 2012?

We have small but positive earnings accretion in 2011 in the plan.

Generally from a planning perspective, as a portion of those acquisitions that are in that number, have not occurred yet.

We assume either those would be neutral or slightly negative within the year.

Depends a bit on the timing as to when they occur.

But overall, slightly positive and obviously in 2012 and beyond, we intend to ramp up those results which is why we are doing these acquisitions in part.

So, net net may be flat.

Past acquisitions and what do you expect to do this year just in terms of the earnings impact?

And then for next year positive?

For 2011, it would be a few cents accretive based on the deals that we have.

The important point, though, which is the one David brought out is for the additional one to two that we haven't yet executed, but are sort of in our thinking, depending on the timing of that could influence that number.

So in other words if those deals happen later in the year, and we have purchase accounting that happens late in the year, there could be some impact there.

But right now, our thinking is a few cents favorable in 2011.

Got it.

Thank you.

Terry Darling of Goldman Sachs.

Thanks.

And David, I want to thank you for the kind of bridge on page 7 on the operating margin walk.

I'm wondering if you can talk us through those buckets as it relates to the second quarter year over year perspective and kind of how those pieces change?

You talked about price raw materials getting a little bit better, presumably you are still assuming that is a little bit net negative.

Maybe we can start with that one?

Yes, so what we expect is in the second quarter that, as you just said, we exited Q1 with better price performance and we expect that to continue.

But I believe that in Q2 we will still be somewhat negative.

Obviously, as we laid out here, the Japan earthquake will become more significant in Q2 on the negative side before the second half, basically trending towards zero.

The pension OPEB expense is a constant through the year.

So, you can expect that to be similar and then obviously our organic growth in holding the guidance at 6 to 7.5 this 8.9 is slightly above what we expect to be the case for the year.

And obviously Q2 will be pulled down a bit by Japan and could be to the extent that we see some inventory correction in the Optical space.

Okay, but, so, David, the $0.10 or so I guess that equates to about 120 basis points negative just to your point there?

Is that about right?

Is there something in the tax calisthenics that make that a little different?

Could you repeat the question?

It wasn't clear.

So on the Japan earthquake impact in the second quarter, you quantified that from an EPS perspective at, I think, $0.10 at the high end.

If you just work your way back up, unless there is something funny with the tax calisthenics for just Japan, relative to the Company total, that would be about 120 basis points impact in the second quarter.

Does that sound right or is that too strong?

We've showed you $0.07 to $0.08 on Japan on chart 9 in the second quarter.

Sorry, $0.07 to $0.08.

Yes.

So that would translate, I don't know the exact number, but it wouldn't be the 120, it would be something a little less than that.

Okay.

And then on the organic volume leverage, I mean that Q1 bridge kind of implies 10% incrementals.

Presumably that's the dampening effect of the year-over-year strong growth in SG&A and R&D.

So that would moderate in the second quarter to where the base volume incrementals would go higher.

Is that fair?

Yes.

If you look at year-over-year Q1, the leverage we got on our growth, it actually ex factors looks pretty typical of what we expect from organic volume leverage.

The ex factors of course are those captured on the page plus another one which is on a sequential basis, of course, we had option expense that is more heavily weighted in Q1.

And that is going to come off in the subsequent quarter.

So that all other things being equal, you can expect an improvement in our margin just due to the reduction in terms of option expense.

That number in Q1 is about $60 million higher than it will be in Q2, Q3 and Q4.

The frontloading of the options expense.

So it sounds like wrapping all that, down year-over-year, but less significantly than Q1.

Correct.

Great.

Thanks very much.

John Roberts of Buckingham Research.

Maybe I will finish with one on LCD since that is where you didn't want us to focus.

The full year 2011 guidance previously had been flat to down 5% I thought.

And I thought the first quarter might be one of the tough or worse comps, but it was actually up mid single digits that's there.

So as we go to the second quarter and third do we -- are we still going down?

I guess I'm just trying to -- trajectory of the year as we progress here through the next couple of quarters.

Yes.

So the trajectory for the year, what's true is that we think that first of all that D&G level, the kinds of margins and growth we showed at the total Big B we think is still pretty good guidance for the year.

We've got, as we talked about, very good performance in terms of traffic safety.

Seasonally that will get better.

C&G, the consumer graphics is continuing to perform well.

So if you look at the whole package, we think that D&G guidance is pretty good for the year.

If you look at Optical specifically, yes, Q1 came in well as we recovered off of the very weak performance in Q4.

If you look out for the year, what we expect to happen is, that in Q2, it wouldn't surprise us if there is an inventory correction in the channel.

And then secondly, if you look at the half year, the second half of the year, certainly end market demand is forecast to be improving.

But we do foresee the likelihood of some lower level of attached rate for us for TD to the tune of down to 25% attachment rate.

So as I said, when you add it all up, we think D&G guidance is quite good, but you might get some level of remixing both across the quarters and between businesses to get there.

The flip side of this coin is that tablet demand and Pad demand which you know is just -- it's going off like a rocket ship.

And we are the suppliers to those folks.

So you've got this kind of eddy -- pools and eddies, shall we say, across that display of business, the Optical systems business where you have got some parts that are really just more rocket ship strong and others which are going through the typical torture cycle like LCD, where it is every sort of -- it's a micro cent per square light-year or -- at issue.

And that is why people make switches.

So we had this is a battle that we fought and lived and sometimes one and I don't think we've lost it very often, but we've certainly got our nose bloodied once or twice.

And I don't think this is going to stop.

But it is why we point it out that as we are growing in so many of these other spaces, so quite wonderfully, with so much innovation across the Company, that ultimately less and less and less, over a period of time, this business becomes a smaller piece of our puzzle.

And obviously then, make it less important to you and more easily manageable for us.

But I still think, ultimately, we will be the last man standing in this business, and this will then mature to a nice steady business with reasonable margins and maybe GDP plus growth rates.

That is where I think this ultimately goes in, say, three or four years time from now.

Thank you.

Thanks.

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.

Well thanks, everybody, for joining us.

A great discussion.

Appreciate the questions.

And we look forward to talking to you very soon.

Bye-bye.

Thanks.

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.