3M (MMM) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M second 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, July 26, 2012.

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

Thank you.

Good morning everyone, and welcome to our second quarter business review.

With me today are Inge Thulin, 3M Chairman, President, and Chief Executive Officer, and David Meline, Chief Financial Officer.

Before we begin, I would like to mention just a few calendar items.

We will announce our third quarter earnings on Tuesday, October 23 and our fourth quarter earnings on Thursday, January 24.

And as I mentioned back on our April call, we're planning to host our next Investor Day here in the twin cities on Thursday, November 8, so please hold this date on your calendars.

Please take a moment to read the forward-looking statement on slide 2. During today's conference call, we will make certain predictive statements that reflect our current views 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 important risk factors that could cause actual results to differ from our predictions.

So let's begin today's review, and I'll turn the program over to Inge.

Please turn to slide number 3.

Thanks, Matt.

Good morning, and thank you for joining us on the call today.

As you have seen, Q2 was a very similar to our first quarter.

We again saw superb operation and execution by our Team.

We continue to grow our earnings, and I'm pleased by our broad based margins performance.

Second quarter EPS was a record $1.66, up nearly 4% year on year.

We grew operating income nearly 4.5% to $1.7 billion with operating margins of 22.9%, up 1.3%(sic-see presentation slides "1.3 percentage points") year on year.

All six of our businesses posted margins above 20%, reflecting strong execution across the board.

The revenue side was also similar to the first quarter.

Sales were $7.5 billion, down 1.9%, including a negative currency impact of more than 4%.

Against a continued and certain macroeconomic backdrop, organic local currency growth was up about 2% with increases in all of our businesses except those affected by weakness in consumer electronics.

Graphically, the Americas once again led the way while Asia-Pacific was down slightly.

Our Teams in western Europe operated with very good discipline in that very challenging environment.

In fact, operating margins improved almost 2 points there.

Over all, Q2 demonstrated 3M's ability to deliver against weak segments and regions, but to me, the real story goes well beyond our second quarter performance.

We approach 2012 with caution and a conservative plan, a plan we continue to execute with discipline and diligence.

Clearly, it was the right plan, and we got a quick start on it.

Our plan called for tight control over discretionary spending, and we certainly did so in the first half of the year.

Needless to say, that level of cost control will continue for the foreseeable future.

Last, but certainly not least, we returned over $1 billion of cash to shareholders through dividends and share repurchases in the quarter.

Now Dave will take you through the detail of the quarter.

David.

Thank you, Inge.

Let's begin by reviewing the income statement.

Please turn to slide number 4. As Inge said, our Business operated well in the second quarter as we delivered outstanding profitability in the continued soft economy.

We drove excellent factory performance, and costs remained under very good control.

Sales declined 1.9% year on year impacted by weak overall economic conditions and also by the stronger US dollar.

I will elaborate on sales in just a bit.

Conversely, gross profit dollars increased by 0.7% versus last year's second quarter.

SG&A cost declined 3.3% year on year, reflecting prudent caution on discretionary spending, and R&D investments increased 1.1%.

We continue to invest to support future innovation and technology development.

In total, operating income grew by 4.4%, and operating margins were a solid 22.9%, an increase of 1.3 percentage points year on year.

Major components of the change in operating margin are detailed on the right side of this chart.

Selling prices increased net of raw material price changes, adding 1.6 percentage points to operating margin, and foreign exchange impacts, net of hedge, added 0.3%.

Higher year-on-year pension of OPEB expense hurt operating margins by 0.3%.

Earnings for the quarter were $1.66 per share, an increase of 3.8%.

Average diluted shares outstanding declined 3.3% year on year to 702.6 million, resulting in a $0.05 positive impact to earnings per share.

The second quarter 2012 tax rate was 30.1%, up 3 percentage points year on year, which hurt earnings by $0.07 per share.

As a reminder, in the second quarter of 2011, we realized a one-time tax benefit from reorganizing one of our international subsidiaries, a benefit which did not repeat this quarter.

During the quarter, we recognized insurance recoveries related to last year's earthquake and Tsunami in Japan which added $0.02 to earnings per share.

And finally, we absorbed $0.03 cost in the second quarter related to relocating a portion of our manufacturing operations from western to eastern Europe along with consolidating certain manufacturing in the supply change support activities within western Europe.

Once again, operating margins improved by 1.3 percentage points to 22.9% as our Teams are executing very well.

Please turn to slide number 5 for a more detailed look at our sales change for the quarter.

Sales for the second quarter were $7.5 billion.

Organic local currency growth was 1.9% driven by higher year-on-year selling prices, and volumes were flat versus last year's second quarter.

Acquisitions added point 0.5% to sales in the quarter.

Foreign exchange impacts reduced sales by 4.3 percentage points as the US dollar strengthened considerably against the Euro and other currencies.

On a total dollar basis, sales declined 1.9% year on year.

Organic local currency growth in Latin America/Canada was 11.4%, another strong showing by our Teams in that part of the world.

All six of our Businesses contributed to the increase, with three Businesses growing double digits, namely Electro and Communications, Health Care, and Safety, Security and Protection Services.

Organic sales growth in the United States was 3.6%.

Organic local currency sales declined slightly in Asia-Pacific as strong sales in both Health Care and Industrial and Transportation were offset by slower year-on-year demand in the consumer electronics industry.

Japan declined 2%, and China was up slightly year on year.

We expect to see improving growth rates in China in the second half of the year.

On an ex-electronics bases, organic local currency sales growth was 6% in Asia-Pacific.

We anticipate that our growth rates in consumer electronics will begin to improve in the third quarter and continue into the fourth.

This improvement is due in part to easier comparisons, as our sales to this market slowed in the second half of 2011.

But of course, there are other factors in play, such as the timing of customer new product launches.

In EMEA, or the combined Europe, Middle East, and Africa, second quarter sales declined 1.9% on an organic local currency basis.

Regardless, challenges remain in western Europe as these countries work through their economic and physical issues.

We remain focused on what we can control, such as driving for additional market share and maintaining firm cost discipline.

So now let's dig into our six business segments.

Please turn to slide number 6. Industrial and Transportation generated sales of $2.6 billion in the second quarter, an increase of 4% on an organic local currency basis.

The growth was very broad based, led by double-digit increases in both automotive OEM and aerospace.

We also posted good growth in industrial abrasives and our energy and advanced materials businesses.

On a geographic basis, organic sales in local currencies increased 8% in Latin America/Canada, 7% in Asia-Pacific, and 5% in the United States, while EMEA declined just slightly in the quarter.

Operating income was $614 million, a year-over-year increase of 13%, and margins in the business improved by 2.8 percentage points to a solid 23.4%.

Industrial and Transportation is the largest of our six segments and continues to generate significant productivity and profitability.

Now let's move to Health Care.

Once again, our Health Care Team delivered superb results.

Sales were $1.3 billion and operating income grew 13% to $414 million.

Operating margins exceeded 32%.

Sales in the second quarter increased more than 5% on an organic local currency bases.

All businesses and geographic areas contributed to this growth, with particular strength in food safety and health information systems, or HIS.

Both HIS and food safety are priority investment areas for us, and we are pleased to see another quarter of high growth in these spaces.

HIS also closed the acquisition of CodeRyte in the second quarter.

CodeRyte is a leader in clinical natural language processing technology and computer assisted coding solutions for outpatient providers.

It's a great business in an important technology area and a natural adjacency to our core coding and classification technology base.

There are early signs of strong synergy between our businesses which will enable further growth for HIS.

Looking geographically, we're pleased with our progress in emerging markets.

These countries naturally seek higher quality health care, and our investment in these areas are beginning to pay off.

In the first half of 2012, organic local currency growth in emerging markets was more than 14% for Health Care, led by our skin and wound care and infection prevention businesses.

Of particular note this quarter were China and Mexico, each of which exceeded 20% organic growth in local currencies.

In developed markets, we posted positive organic local currency growth despite weakness in Europe.

This is a testament to the strength of our Health Care portfolio and the quality of our Teams.

Profit margins and Health Care were a strong 32.3% in the second quarter.

Our factories continued to run very efficiently, discretionary spending is under firm control, and the portfolio mix was excellent.

Now let's look at Consumer and Office Business.

Sales were $1.1 billion this quarter, up 3% on an organic local currency basis, and operating income rose more than 10% to $222 million.

Operating margins rose 1.5 percentage points year on year to 21%.

From an end-market perspective, top line growth was quite good across the mass retail, DIY, grocery and drug channels.

This growth more than offset continued weakness in office wholesale and retail, which continues to be impacted by high unemployment levels.

Acquisitions added nearly 3% to second quarter sales, largely related to the October 2011 purchase of GPI Group.

GPI is a French producer of tapes, hooks, insulation, and floor protection products for the Home Improvement Channel.

Integration is moving along well, and the business is on track towards its financial objectives.

On a geographic basis, organic local currency growth was 9% in Latin America/Canada, 5% in Asia-Pacific, and 4% in the US, while EMEA declined 6% during the quarter.

Safety, Security and Protection Services business also had a good quarter.

Sales were just shy of $1 billion in the second quarter, and operating income grew 6% year on year to $258 million.

Operating margins rose 2 full percentage points to 26%.

A number of factors drove the margin improvement, including a net positive impact from price and raw materials, improved factory utilization levels, and positive mix.

Total organic local currency sales growth for the business was 3%, with significant contributions from the infrastructure protection, personal safety, and building and commercial services businesses.

Second quarter sales declined year-on-year in the securities system business.

Looking geographically, sales rose more than 20% in Latin America/Canada and 2% in both Asia-Pacific and the US.

Sales declined 4% in EMEA.

Let's take a look at our Displaying and Graphic segment.

Sales in the second quarter were $882 million, down 7% in organic local currency terms.

Optical system sales fell 20% versus last year's second quarter, largely driven by LCD TV.

On a sequential basis, sales improved by 8%.

We continue to see good growth in 3M films for battery powered devices, such as smart phones and tablets, where 3M's value proposition remains very strong.

Also in D&G, architectural markets and commercial graphics continue to grow nicely.

Sales in traffic safety systems declined slightly in the quarter on an organic local currency basis.

On an organic local currency basis, sales grew by 9% in the United States and 8% in Latin America/Canada.

Sales declined 14% in Asia-Pacific, largely electronics related, and 6% in EMEA.

Operating profits in Display and Graphics were $179 million, and margins were 20.3% for the quarter.

Lastly, let's review Electro and Communications.

Second quarter sales in this business were $824 million, operating income was $195 million, and operating margins increased 60 basis points to an impressive 23.7%.

Sales were down year-on-year in our consumer electronics-related businesses.

Our 2012 plans in this space called for a challenging first half, which has been the case.

We continue to believe that growth will improve in the second half of 2012 due to a combination of improved industry demand and easier year-on-year comps.

Organic local currency sales increased in our electrical markets business, while telecom supplies business declined a bit.

In geographic terms, Latin America/Canada rose 13%, and the US increased 6%, while Asia-Pacific and EMEA declined 5% and 8% respectively.

That concludes my discussion of the business segment results.

Please turn to slide number 7. Free cash flow for the quarter was just over $1 billion, down $125 million year on year.

This amount includes a voluntary $250-million contribution to our US defined benefit plan.

We made a similar-sized voluntary contribution in the first quarter of this year, putting total year-to-date discretionary cash contributions at $500 million.

This amount is consistent with our plan for the year.

In total, second quarter pension and OPEB contributions totaled $335 million, which was $271 million higher than Q2 of last year.

For the full year, we anticipate total contributions of about $1 billion to our pension and OPEB plans, and we remain very well funded at the moment.

On the positive side, free cash flow benefited from lower working capital investment and higher levels of net income.

Capital expenditures were $358 million, up $63 million versus the second quarter of last year, and we remain on track to invest $1.3 billion to $1.5 billion for 2012 in total.

Free cash flow conversion was 88% in the quarter versus 100% in last year's second quarter.

Adjusting for pension and OPEB contributions, conversion was 117% this quarter versus 105% in Q2 of 2011.

We returned over $1 billion to shareholders in the second quarter, including $410 million in cash dividends and $639 million in gross share repurchases.

On a final note, during the second quarter, we issued $1.25 billion of long-term debt spread over 5 and 10 year terms at record low corporate yields.

So that concludes my discussion of our second quarter financial results.

Now Inge will address our forward outlook.

Thanks, David.

During uncertain times like this, I'm especially appreciative of 3M's business model, a model flexible enough to allow investments to improve the business, and yet disciplined enough to deliver earnings and superior margins when economic growth is challenging.

We are well known for our culture of innovation, but just as real is our culture of continuous improvements.

For example, in the first half of this year, we absorbed restructuring cost of $0.07 per share.

Given that most knowledgeable observers see slow or stalled global growth in the second half of the year, we will continue the approach that served us very well in the first half-- strong execution and productivity; good cost discipline; and continued investments and actions to improve and build our businesses around the world.

We are, in fact, increasing our momentum to move 3M forward.

For example, in the quarter we announced the acquisition of Federal Signal Technologies Group.

FC Tech is focused on electronic toll collection, parking management, hardware and software services, key adjacencies to our traffic safety systems business.

On last quarter's call, we talked about investments in Aerospace and in a newly-formed Business, Mining, Oil, and Gas Solutions.

They both progressed very well this quarter.

Aerospace grew 24%, and mining, oil, and gas at 20%, significantly faster than the market.

I look for great things from these businesses as they both operate at the crossroads of advanced technology and megatrends.

As you know, 3M is a true pioneer of international business.

Many of our international companies have existed for decades.

For example, 3M Brazil dates back to 1946.

Over the years, we have developed global capabilities that are second to none.

Our newest frontier is sub-Saharan Africa, where we just launched an initiative to broaden our presence in this emerging market.

In Q2, we announced the formation of the new subsidiary in Nigeria and reactivated our operations in Kenya.

We believe sub-Saharan Africa holds long-term opportunity for 3M, or more than $0.5 billion dollars.

Also in the second quarter, we took steps to establish a stand-alone subsidiary in Saudi Arabia.

3M already does sizable business there, and with a wholly-owned subsidiary, we can make a step change in our growth there.

We expect 3M Saudi Arabia to be in full operations on September 1. Here again, we see long-term opportunities in the $500 million range.

We took actions this quarter to fully realize opportunities like Africa and Saudi Arabia by increasing the effectiveness of the way we go to market and serve customers.

In addition, we just appointed a new Vice President for Global Sales Operations to increase sales skills, competence, and productivity around the world.

The new VP for Global Sales is an experienced sales professional, a proven leader who has led 3M Businesses in Europe and North America with great success.

Also, with the increasing importance of digital platforms in the marketplace, we have elevated eTransformation with an appointment of a Vice President for this function.

The new leader has both the understanding and experience to lead our Company-wide efforts, as he has led similar efforts at a number of companies before joining 3M.

The objective is to build and scale our E platform to realize rewards in increased sales, brand presence, and productivity.

These two appointments, along with the previous appointment of a Vice President of Global Marketing Excellence, will significantly increase our sales and marketing horsepower at the center of the Company and improve our capability to drive growth and penetration everywhere.

That is a quick summary of some of the ways we are moving the Company forward.

I now turn to our outlook for the balance of the year.

Please turn to Slide 8. First, my confidence in the Company's ongoing performance lead us to affirm our EPS outlook in the range of $6.35 to $6.50 for the year.

We do so with full consideration of additional head winds from currency in the second half.

Looking upon sales, we expect organic local currency growth of 2% to 5% for all of 2012.

We trimmed the high end of the range by 1 point based on the first half and our views about global economic activity going forward.

Strong pricing should offset slightly lower volumes and comps become easier as the year goes on.

After the good margin performance in the first half, we are raising the bottom end of the margin range from 21% to 21.5%.

And the tax rate remains unchanged.

To me, the second quarter demonstrates that 3M continues to operate very well with alignment, discipline, and always with an eye towards opportunity.

Thank you for your attention.

We will now take your questions and comments.

(Operator Instructions) And our first question comes from the line of Ajay Kejriwal at FBR.

Please proceed with your question.

Thank you.

Good morning.

Good morning.

Good morning.

So getting really impressive pricing here of up nearly 2% in the quarter.

So maybe if you can talk about the outlook for the rest of the year.

How should we be thinking about pricing?

And then also raw materials as they moderate, is that a benefit to the spread and margins?

Sure.

Sure, Ajay.

So what I would say first on pricing, as you probably recall, we had indicated we'd get somewhere between 0% and 1% on the year.

And what we expected given the way prices developed last year is we would see some level of decline as we move through the year.

So if you look at the first half, we've been pretty solid and stable there.

We did 1.7% in the first quarter and now 1.9% in the second.

But again, as you look at the trends for the year, we'll see that moderate somewhat.

On the other hand, we had said 0% to 1%, and it looks now like we'll probably come closer to 1% for the year than flat.

In terms of raw materials, what we're seeing, like everyone else, we are seeing that the raw materials are certainly softer than we might have expected at this stage.

So we have raw material price inflation of 2% in the first quarter.

We had indicated we thought we'd come in at 1% to 2% for the year.

The second quarter actually now declined.

So from that 2% level, we were around flat in the second quarter in raw materials.

And we think for the year in total, it's most likely will be closer to flat than those higher levels.

So yes, it's contributing, certainly, to our margins presently, and that we expect to continue at some level through the balance of the year.

Good.

Thank you for that.

And then on the discretionary spending, maybe talk a little bit about the initiatives you've put in place.

And then, we're obviously seeing the benefit on the SG&A rate there.

Could you maybe talk about what's the opportunity you see on cost tightening?

Well, we continue the rest of the year as we started the year, which as I said earlier, we went into the year with a plan that was conservative, and we've been very cautious.

So -- and you have some parts of the world like western Europe at the moment where there is challenges relative to economic outlook.

So we are managing that very, very tightly.

At the same time, when we see opportunities for growth, we invest, and we talk at the last call specifically around Health Care, which is everywhere around the world, and we see very good traction.

We also invest in personal safety.

And we have those two new units that we talked about last time in terms of mining, oil, and gas and aerospace where we continue to invest when we see the opportunities.

But we are, yes, cautious as we go.

And specifically, I think big credit should be given to our west European Team on that the whole time, day by day.

So I -- we hope at the time that we can let up, but the important thing here is we have the plan, which we now look upon to say it was a good, solid plan we roll into the year on, and we are very pleased in how the Team are executing it.

And as you saw also in terms of research and development went up 1.1%, meaning that we are committed to growth for the future in terms of investment.

So I think it's a good balance here.

Very helpful.

Thank you very much.

I'll pass it on.

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

Please proceed with your question.

Thanks, and good morning.

I actually want to ask you to dig into a little more detail on the pricing question.

So Latin America looks like it was up 440 basis points on pricing.

The US 290, EMEA 270.

This kind of pricing power is -- continues to be extraordinary.

And the question I have is, can you give us a better sense for the kind of actual actions you're taking on pricing?

Is this -- whether it's material contract, escalators, what are the -- what things are you doing?

It's not mix, I know.

So what are you doing that's allowing you to get that kind of pricing quarter in, quarter out lately?

Sure.

So, Steve, basically, as you know and we've talked about a number of times over the last now two years, that the Company really started gearing up to make sure that we were adequately recovering our material cost as we moved through last year, and that continued into the first and second quarters here.

So 1.7% in the First Quarter, overall 1.9% in the second would indicate that we've taken some fairly limited additional increases here in Q2.

And not surprisingly for us, at least, we have very good price retention.

The products that we offer in these markets around the world, we work very hard to keep them differentiated and fresh, which enables us to maintain our prices and offer things that are attractive to the market.

So I wouldn't view it as something different today than we've been experiencing in recent times.

Perhaps just the comps are showing up just a little more strongly right now.

Does that explain Latin America particularly?

Latin America, a certain portion of those products we price in dollar terms.

So when you look at a depreciating currency environment, such as Brazil has a 20% decline in currency year over year, we do pick up some price on a portion of the products as they're pegged to the dollar.

Okay.

So that's separate from all of the currency and packs you call out.

Okay.

Got it.

And then secondly, when you talk about that second half top-line guidance baking in a more conservative view of the economy, it still looks like there's something like somewhere around at least low single-digit and potentially mid to high single-digit growth baked in on the organic side.

Is that -- how are you thinking about that for the second half?

Because it sounds like you're still -- there's still acceleration here.

And you mentioned comps.

Is it all comps based, or what are you planning on?

Yes.

It's a good question.

So if you look at the ranges for the year, we've got a range of now 2% to 5% for the year in total.

We did 2% in the first half.

So obviously the scenario in which we'd be at that low end would be such that we would continue on the same path.

And the high end, of course, does indicate that we'd have some pickup.

Where do we see that pickup coming from?

Several factors.

One, certainly, that's been impacting us, as you know, is the electronics sector, which we do see the recovery developing in the second half exactly as we previously indicated in our planning.

So that's contributing to our second-half outlook.

And then certainly, there is a component of it which is the comps which, again, last year in the second half we had a deterioration.

So even with stable revenue, we would see some level of pickup there.

The electronics, what gives you confidence that that could materialize?

We were seeing as we exited the quarter, we're starting to see that turnaround develop in terms of the volume.

So it starts with looking at the indicators of forward demand, including areas like semiconductor fab and our consumer electronics outlook that we observed.

And then observing what is in our forward orders.

And we see, importantly, the inflection developing now as we've existed the second quarter.

And again, there's a comp issue that helps that as well.

Thanks, Steve.

Okay.

Thanks.

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

Please proceed with your question.

Hi.

This is (Inaudible) calling in for John.

A quick question on pensions.

Based on some of the recent pension funding policy changes, would you opt for some of the funding relief options, and how should we think about your funding requirements looking to 2013?

Sure.

So in terms of our overall pension funded position and how we think about pensions, we have a view that the right approach to this is to be targeting a range of funded status, which is a quite a healthy one.

So somewhere bracketing the 100% funded position, we were in the mid 80% funded status as we ended last year due to the declining interest rates.

And so we made a decision this year to do this extraordinary additional funding to make sure that we don't vary from our longer-term goals.

So hence, the additional funding that we put in this year, which we expect to be $500 million.

So, point there is to keep the pension fund well funded.

Secondly, as to the change in the funding requirements, that doesn't impact us because that would give relief to companies that are facing mandatory contributions, and of course, based on the way we manage pension funding, we don't face that kind of a situation.

So it doesn't have any impact on 3M.

If I look into 2013, last year about this time, we were expecting to see pension expense requirements actually decline in 2012 and thus not have the additional requirements for also additional funding.

But the reality was is we saw interest rates decline as we went through the year.

So we actually had a pension increase in our expense last year and also our funded status decline which we've been addressing this year.

So as I look into next year, what's true is that we would expect from an expense perspective to be stable or see some additional decline.

But quite honestly, I'm a little cautious to make a call at this stage given our experience recently and where interest rates seem to be wanting to go.

Okay.

Fair enough.

And then a quick follow-up question on the electronic side of the Business.

Could you talk a little bit about some of these share gains that you're seeing in the semi market and some of the drivers behind this and if there are any regional factors behind the business winds?

Yes.

You know, we are broad based, as you know, in consumer electronic.

Everything from semiconductor to data storage to smart phones to notebooks to tablets and touch panel.

We are (inaudible) moving with the market.

And when we looked upon the outlook a quarter ago and then look upon it now again, basically, we can confirm the movements in the market.

There's a slight uptick on tablets versus notebooks, but overall, the growth is coming as we're expecting for the rest of the year.

The other thing we see on semiconductors, which is an early indicator, we see that, in fact, continue to improve, which is good.

And other thing is also, if you go back a year ago in comparison, the Thailand flooding is now -- restructuring there is done, meaning we see a positive comparison for us as we move forward.

Okay.

Great.

Thanks very much.

Thank you.

Our next question comes from the line of Scott Davis of Barclays.

Please proceed with your question.

Good morning, guys.

Good morning.

Guys, you have a sense of what your customers are doing with their inventories right now, whether we're kind of past the destock or whether there's another round of destock just ahead of us?

Well, as you can imagine, we are following that very closely.

And when we have scanning our many Businesses and end markets, it looked like overall there's a very good line in between demand and inventories.

So we don't see an issue there.

And in fact, I think since the last recession, almost all Company are now managing inventories very, very carefully.

So there is not an issue there as we see it.

So inventory versus demand is well under control.

So that's our view at this point in time.

Yes.

If I could, the one exception would be we did see the LCD panel inventories have risen to a pretty high level.

Not a big factor in the business any longer, Scott.

Last quarter, optical systems represented now 4% of our total revenue as a Company.

And, of course, only about a third of that is in the LCD business.

But nonetheless, that's the one area that we observe a buildup of inventory.

I think that was the only place we saw a small tick up on the running rate, which is close to 7 weeks, I think.

Okay.

Thanks for that.

And just as a follow-up on -- I know there's been a lot of questions in margins, but in Europe specifically, where it's pretty hard for us to imagine how you can take margins up by a 200 basis points in such a tough environment, how much of that is a benefit of past restructuring?

You talked about discretionary costs and things that are under control.

But is there some permanent step-up in that margin rate that we can expect going forward just past work that you've done there in Europe?

Well, first of all, let's talk about western Europe in terms of perspective.

We have been on western Europe for quite some years.

And you maybe recall that we made a restructuring probably 2.5 years ago when we made very clear that there is a difference in between western Europe, central east Europe, and middle east Africa.

So we started out very early.

And at that time, we also regionalized western Europe.

So I think, first of all, we have to say, this is nothing that is coming here that's a surprise for us.

We were very early into the game in order to make sure we prepared ourself.

There is a combination, of course, of benefit of restructuring in terms of when we did the regionalization where we reduced the layers of management and made sure that we continue to have local execution in terms of sales and marketing, but as much as we could in terms of management and back office type of consolidated at on a regional base, meaning Nordic, Alpine, Benelux, Iberia, et cetera.

So I think that is one of the things that is now paying off for us, so we are very pleased we were early on that game.

Secondly, of course, they are now holding very tightly the spending in that part of the world.

And we have a hiring freeze and, in fact, also reduced, I think, over 300 people here during this year.

So it's the combination of all of it.

And at the same time, Patrick Deconinck, that is leading our west European organization, it's his Team is focusing as much as they can to gain market share in the market and elevate elements relative to customer interaction.

So I wouldn't like to -- as to look upon western Europe now like this is one quarter that just everything came true.

This has been a longer period of time that we were working a very diligent plan.

I would just add, Scott, what's also true is there is a mix effect.

If you look at one area of the Business that grew in the second quarter was Health Care in Europe, and that certainly helps our mix.

Okay.

That's very helpful.

Thanks.

I'll pass it on.

Thanks, Scott.

Thank you.

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

Please proceed with your question.

Thank you.

Good morning, everyone.

Good morning.

I was hoping to start first on the FX tack acquisition and road tolling.

It seems like this would be a good fit for 3M.

Could you just discuss the competitive landscape?

You do have some entrenched competitors there.

And maybe reflect a bit on what the mix might be in terms of systems and consumables in this business.

First of all, this is very much a business into United States, right?

So it's United States and UK a little bit.

And if you look upon the mix for it, I would say it's 25% of each, relative to parking, toll software, cameras, and the hardware in terms of tolling.

So 25%, 25%, 25%.

There is a competitive landscape that we are now taking on.

But this is a great move for us because this is adjacency that going into TSS for us where we have a global leading position on signing.

So it's absolutely perfect for us in terms of making sure that we build out more relevance in that market space for us.

And I think all those components, that we would be ready to integrate them and execute very well, and we will focus in on the pieces that we have the business today, which is United States to most portion, and then a smaller piece in UK.

And as soon as we've gone on to the integration and build it in, after that, we will see how we can expand it from a global base.

But we have very good base, and that's where we will start to make sure we integrate it to a very strong division we have in traffic safety system solutions.

Thank you, Inge.

And then over on the optical film side, lot of discussion about the next iPhone and the implications of this new, what they call in-cell technology, where they're going to eliminate the touch screen layer.

What are the implications for the optical film content where you -- if you remove that layer, it sounds like they're already getting better display graphics on this.

But is there a difference in content potential for 3M?

Well, as you can imagine, we are working very close with all the companies in this area, right.

And whatever new technology that is coming, we are in the middle of that in order to help and support with solutions.

So I would say that we have seen still big opportunity for us, specifically in hand-held and smart phones as we move ahead.

So I can make sure for you we're in the middle of it and probably will be more of up sides for us than anything else, broad based in what I call tablet and hand-helds.

Great.

Just last one for me.

On the consumer side, back-to-school third quarter, what are you baking in terms of the assumptions year over year, and any comment on the Avery Dennison consumer performance this quarter?

Yes.

In terms of the Consumer and Office Business overall, we continue to expect -- we had set out a range of growth for the year for that Business, and we don't see any reason why that won't come to pass.

Certainly, the retail consumer, as we commented, has been -- it's been relatively tepid, the demand in the space.

Our performance we saw improved from first to second quarter, so we were pleased with that.

And certainly, there's indications that some level of improvement in that particular area is going to continue now in the back-to-school period.

So don't really know the answer, but I would say on an overall trend basis, we're confident and feel good with the outlook for the Business for the year.

And the pending Avery Dennison acquisition?

Well, nothing new.

We still expect to close that in the second half of the year here, and we're still in the negotiations.

So nothing new.

We look upon it positively, and we hope that we will be closing up here before the year is over.

Thank you, Deane.

Thank you.

Ladies and gentlemen, as a reminder, please limit your participation to one question and one follow-up.

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

Please proceed.

Thank you.

Good morning, gentlemen.

Good morning.

I was wondering if you could share with us, is there anything to gleam from the progression of organic sales over the course of the quarter, and there's been some talk of potentially a CapEx strike in the US grinding into year end and all the expected political and fiscal drama.

Have you seen any discernable change in trend particularly in the June, July time frame?

No, actually.

Well, first of all, on the second quarter, it was pretty stable through the quarter, so we didn't see -- and obviously, we're looking very carefully.

We didn't see any indications of a change in trends.

And that's true through July now.

So some, obviously, individual sectors, individual geographies, one month versus another, you can have some ups and downs in an economy like this.

But net-net, we don't have anything that would cause us to say there's a material change in the outlook, which is how we characterize the second half now.

And then in terms of CapEx, not sure -- if you talk about as that drives our own demand, we haven't seen, again, any discernable change.

If we look at our own deployment, which is at some level an indicator of longer-term requirements, we continue to get a bottom up view that says we have demands for capital based on the view of the Business that we need to continue to support growth, and there is no reason to vary from that.

And if you see some sectors, like our traffic safety had a very good second quarter, which is partly related, if it were, to Government funding in that particular case.

Thank you.

And I was wondering just as a second question, could you elaborate a little bit more on China, the better performance that you're expecting?

Is it just this ramp in the electronic supply chain that you've already discussed so far here this morning, or are there other things going on there that are giving you a little more confidence into the back half?

Well, let's first look upon the facts for us.

First of all, revenue in the quarter was stable versus Q1.

So we had very similar growth rates for the second quarter versus the first quarter.

And Health Care is growing very fast for us, 20% plus.

And we also show (inaudible), show improvement versus Q1, which is a good sign.

So when you take out electronics from China, we grew in the quarter 10% organic locally versus 8% in Q1.

So we make a step change relative to growth, generally speaking.

And when we look upon the rest of the year, we look upon it to be from a dollar perspective similar to the first half of the year.

But due to the comparison, we see growth rate accelerating.

And as we talked about last time, as the capital things that have impacted China for us, which is, of course, export specifically to Europe, electronics, and then local consumption.

And we will look upon it as we move ahead.

Electronics will improve and also local consumption.

We don't see any improvements relative to export to Europe.

So I think you can look upon it that there will be similar in terms of overall dollar sales but improvement relative to percentage due to the comps and electronic.

And we also see Health Care improving quite a bit.

We're very happy with our Health Care Business in China as we speak, growing very, very fast.

Thank you very much.

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

Please proceed with your question.

Good morning.

Good morning.

You know, some very nice margin improvement.

When you're talking about discretionary cost controls, and specifically the discretionary component, should this kind of SG&A level be something we should think of as a sustainable run rate, or is it really just at this level given the uncertainty and some of those cost controls are going to be lifted when hopefully things improve?

Sure.

Yes, I mean, as you know, Jason, we're always trying to balance coast control with investment in the Business in growth.

Certainly, as we looked at this year coming into '12, we didn't see the opportunity materializing for the kind of growth that we foresee on a long-term basis for the Company, and therefore, we set for ourselves a much more conservative plan in terms of our discretionary spending.

And as you know, that's what we've been actually marching to.

At the same time, that plan we continue to invest in the Business.

That invest both in SG&A and R&D is very steady.

So it's not as if we're carving out and starving investment in the Business over time.

So is that sustainable, is that SG&A margin or expense sustainable?

I would say I don't view it as extraordinarily constrained right now, to be honest.

We're always working on becoming more efficient.

We're always trying to leverage the Business as being a larger Business on an efficient back office, et cetera.

So to me, there is nothing that jumps out in terms of that performance in the context of the current economic environment.

Okay.

Another way of -- I was thinking about it, you distinguished very appropriate between the growth investments, but you haven't cut back on it.

In fact, I think last quarter you talked about accelerating them, I think it was $30 million to $50 million for the year, as distinct from these discretionary cost controls.

So I guess the other way, assuming that you continue to invest in growth, whether times or good or times are bad, is there additional non-growth areas where there is still opportunities for incremental cost cuts?

Well, you know, as I said earlier, we are well known for innovation.

But we're equally good at continuous improvement and make sure that we constantly look for operational excellence and functional excellence.

And I think that's what is driving us the whole time.

So I think it's an important element to make sure that we and you know that we are driving productivity in all functions, specifically in the back office.

So that's an opportunity for us.

We are not backing off relative to investment for growth in the front.

And I think that's a very, very important distinction to make.

And again, it's not the same cut for every Business.

It's based on some opportunities where you can see that it's a short-term, mid-term growth opportunity for some Businesses, like in this time for Health Care and Consumer and Office.

We let them go at a different level of some other Businesses that have a tougher economic environment at the moment, like electronics.

And if I could just add one other perspective on that, we talked -- Inge talked now about $60 million, $70 million that we've directed towards some form of consolidation and restructuring through the first half, which is, quite honestly, very typical of the Business which we're constantly working on productivity.

We're constantly looking how we can improve and be competitive.

And eventually, hopefully sooner than later, the benefits of, if you will, those investments in terms of getting the Business right sized or in the right kind of posture reaps rewards for the Company and that's something that we've been doing continuing basis.

So I think it's all within the same theme.

Obviously, in times like these, you have an extra sharp focus on the area.

But it's something that the Company is always doing.

Thank you.

Thank you.

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

Please proceed with your question.

Hi.

Good morning.

This is actually Ron (Inaudible).

I'm sitting in for David.

Good morning.

Good morning.

Quick question on Health Care.

Obviously, very strong results here.

In terms of margins, what's fair to assume in the back half?

It looks like it was a record margin performance on the EBITDA basis in Q2.

Sure.

So yes.

So obviously, we're very pleased with the way the Business is running.

If you look at the quarter, it's a continuation of a story that we've seen for some time now, which is not only very strong margin performance, but also if you look at the growth of the Business, quite solid and very broad based.

So we're pleased with the way Health Care is running right now.

Why is that the case?

Well, we're seeing growth in all of our divisions.

The factories are running as well as we've ever seen them run.

Health Care, like our other Businesses, obviously have a closed eye on cost.

So in terms of the margin as I look out, I think it's realistic to expect that we'll probably run in the 30% plus range here for a period of time into the future.

Certainly through -- if I look at 2012 in total.

And also we expect to see that in combination with some continuing steady growth.

Understood.

Thank you very much.

Let me make an additional comment here.

First of all, we have a very strong and diverse Health Care portfolio.

And if you look upon the growth rate, emerging market now grew 16% as of late.

And the investment we have done there start to payoff due to the fact that the portfolio there is becoming more relevant for those countries.

So I think it's important that we are targeting good growth and strong margins in this Business, and they are delivering.

And as David said, as many elements there in terms of mix of portfolio, the efficiency in manufacturing, the go-to-market capabilities, but we are still doing those investments as we have talked about on the other calls.

But based on the business model there, I think for the foreseeable future, we should see low 30%s as more likely the margins for us, which is very good.

Thank you very much.

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

Please proceed with your question.

Good morning.

Good morning.

Sorry.

Was that last question about the Health Care margin?

That was on Health Care margin, yes.

Yes, that was on Health Care.

Okay.

Great.

So I won't -- I'll just go back to the transcript.

Sorry I missed it.

The price cost.

So on the pricing side, just quarter-by-quarter, does that step down gradually over the next couple quarters to go on like basically flat in the fourth quarter?

Or how is that -- price is up 2% in the fourth quarter, stepped up a little bit.

Is that how we should think about it?

Will it be another big quarter in the third quarter and then step down?

Maybe if you could just give us some visibility around the comps.

Yes, Steve.

So we're looking for around 1% for the year.

And it does imply a step down.

I would treat it as we think it will be a step-by-step move.

Okay.

And then the raws, will they be negative in the second half, or similarly?

Yes.

So we ran about flat in the second quarter, which was certainly an improvement from the first.

We think we'll be flat for the year.

So that would imply slightly negative in the second half.

Got you.

And then just one last question.

We're looking at it year over year, obviously very strong improvement.

But sequentially as well, your profit was up $95 million.

Your revenue was up $50 million sequentially.

Was there something that kind of dropped out of the first quarter into the second quarter, or was that 4X?

Maybe you could just give a little bit color around the sequential bridge.

Steve, one thing that changes Q2 versus Q1 is we front-end load our stock options expense.

Okay.

We grant options in the first quarter of the year.

So our stock -- our options expense is the highest in Q1, and that's typically about a $50-million sequential change Q2 versus Q1.

Okay.

And that's happened in prior years?

Because last year you had --

Yes.

It did, yes.

Yes, it has.

Okay.

Because in the last two years, you've had more like a 50% incremental instead of 200% incremental.

Right.

I was just going to say, on your revenue question, we -- if you look back at the way we set out the year, we expected the first half to be as it's been, which is basically pretty flat to the second half of last year.

It's turned out to be the case.

Certainly, second quarter was negatively impacted on a revenue basis by exchange more than the first quarter.

But it's very much in line with the first half, second half type of a situation, where the first half would be most modest and some level of recovery in the second half.

But obviously, still something that's quite contained.

Okay.

How much more positive was price cost in the second quarter versus the first quarter?

I'll have to follow-up, Steve, on that.

I'm not sure off the top of my head.

Okay.

Thanks a lot.

Thanks for the info.

Thank you.

Our next question comes from the line of Nigel Coe of Morgan Stanley.

Please proceed with your question.

Yes, thanks.

Good morning.

I just want to pick up on the price cost.

Sorry to keep beating this thing to death.

So you've got 50 bips good news on price versus your prior expectation.

You've got, it sounds like about at least 1.5 points on inflation.

I'm just wondering why just the 50-bips low end is raise to the margin level.

It seems that you should be -- are you more of a bias toward the high end of your 1.5 point, 50 to 1.5 point target?

It just seems that if you put those through the mold, 1.5 point seems very achievable.

So if you look at the margin plan that we've got in place, what we set out for ourselves this year was to achieve a 1% year over year margin increase, which we ran it just slightly short of 21% last year.

The midpoint now of the margin guidance for the year is 22%.

So I think it reflects correctly our continuing level of confidence that we had that we'd deliver on that plan.

If you also consider other factors that would be impacting margins in the second half, you certainly have things like the Avery acquisition, which is not yet in there, so that would have some possible impact.

And then secondly, we still have a range of growth that varies several points, and that could impact margins.

So we think it's a reasonable outlook.

What's also true for us is first half and second half, your margin trend, you normally have a weaker second half in margins, specifically in the fourth quarter, which is also being reflected in the way we're guiding right now.

Okay.

And if I can just ask it a slight different way, if sales come into as lower end of your range, which would seem at this point to be more likely, can you still make the high end of your margin range given the price and material good news?

Ex Avery Dennison.

That's a hard one, Nigel, to exactly connect those dots as to what the other elements of the equation will give us in terms of things like raw material cost and how it flows through.

So I would tell you, I couldn't give you a straight answer on that.

Okay.

If I can just follow-up, it looks like you've seen 1 point out of your volume expectations for the full year.

How does that look by segments?

Repeat that, please?

Yes.

So the 1 point of lower volume for the full year.

How does that look by segments?

So are we losing --

Yes.

Got it.

What I'd say is, if you look at -- and again, if we gave some full-year segment guidance in December and also full-year guidance in terms of the regional split for the growth, the way it looks right now is that we're still foreseeing us being very much in those ranges by six business sector for the year.

The fact is, by trimming the top end, it's more likely you'll have more of them in the middle than perhaps some being at the top of their range, which was a scenario that we had as we entered into the year.

So I think from a planning perspective, you should think about those ranges still being good on a business sector basis.

And then quite honestly, on a geographic basis, the scenario in which the top of that original guidance would have occurred for 3M would have involved, quite honestly, a stronger Asian performance, which is not materializing.

So if you wanted to articulate those ranges by region, we still don't see the ranges being -- we still see them as being good geographically, but that's -- if you want to identify the differentiating factor, that's what I would say.

Okay.

Thank you very much.

Yes.

And our last question comes from the line of Terry Darling of Goldman Sachs.

Please proceed with your question.

Thanks.

Inge, I'm wondering if you might shed a little more light on how you're thinking on capital allocation is evolving, and maybe describe a little bit how the M&A pipeline looks at this point.

We just have started to work on the plan for next year, so we are just in the middle of that.

And as you know, I think capital allocation is an important element for us in order to make sure we prioritize the right Businesses as we move ahead.

So we are just in the middle of that, and I hope we can share more with you in November as we meet again.

In terms of the pipeline for emerging acquisitions, it's solid.

It's -- I would say, as we have a bottom-up process there, we have still Business-by-Business very solid pipeline, and we take a look upon them one by one as they are moving forward.

As you saw, we announced one this last quarter.

We have made a commitment to one earlier in the year.

So it's still robust.

And it's part of our growth strategy as a tactic as we move ahead.

So first of all, organic growth for us complemented with acquisitions.

But the pipeline is healthy and improving, and we are now prioritizing it day by day I would say in order really to understand how it will fit in strategically for the Company as we move ahead.

And the target we have given out earlier in terms of spending, we're standing behind that.

If I could add on, on capital allocation, at least as it relates to the current year, again, go back to the fact that we're tracking very much to the plan we laid out for the year from an operating perspective.

If you look at the big goal post that we've got on how we allocate capital in the year, we said 1.3 to 1.5 on CapEx.

We still think that's a good range.

We said 2 to 2.5 on buyback gross.

I think we've done here in the first half about 50% of that.

So I don't see any reason right now to say that there's a dramatic change in our view there.

But obviously, we need to be cognizant of intrinsic value of our shares in the market.

And then we've pre-funded -- as I mentioned, we pre-funded some debt maturities that are coming up later this year and into 2013, so that was an action we took.

And we've got the M&A guidance out there of $1 billion to $2 billion.

The announced transactions would indicate deployment of slightly less than bottom end of the range in the first half.

But I think $1 billion to $2 billion is still, from a planning perspective a good range, recognizing there's -- we can never precisely plan size and timing of those things.

And appreciating that the update in November is forthcoming, I'm wondering, though, if you can, Inge, just put any light on what any of the debate that you're having with regards to how the plan going forward could shift at all relative to where it's been in the past, and perhaps specifically within the M&A realm, whether larger acquisitions is something you're considering in that mix.

Well, as we had talked earlier, I don't think it's larger by definition.

I think it's a private decision where we have to make sure that we connect them strategically into some of the very important Businesses that is coming out from the private decision process.

And then we are, in fact, making a step-up relative to integration, and make sure that we can do that faster and more professionally as we move ahead.

It's an ongoing process, as you know, when you look upon your Business and evaluate opportunity based on your base, and that is what we're in the middle of talking about as we speak.

Okay.

And then just lastly, David, I wonder on the raw material -- the improved outlook on raw materials, other than steel and copper, which is obviously pretty visible there to most of us out here -- all of us out here.

What other key raw materials are driving that lower inflation outlook, and to what degree are some of those raw materials derivatives of US natural gas?

And perhaps you've got a longer tail to the benefit of that reduced inflation as we think about, again, this ongoing question of sustainability of margins into 2013.

Yes.

If you look at our key raw material inputs, there's certainly a portion of those that are pegged to the price of oil and natural gas now.

You get into this issue of the amount of these derivatives that are coming out of cracking slates, whether they be oil versus natural gas.

But the answer is polypropylene, for example -- propylene-based products which feature in a number -- as inputs to a number of our products.

We're seeing softer pricing there at the moment.

Certainly, we've seen price trends improve on things like paper board, which is an important input to our products.

And in some of those areas, we also see capacities reacting to put a floor on pricing.

Certainly, our experience has been as demand improves and as the outlook for economic activity improves, we would be naive if we thought prices would stay down.

So I think it's going to continue to trend up and down as the market outlook changes.

Okay.

Thanks very much.

Thanks, Terry.

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 today.

I know it's a busy earnings day.

I think we covered a lot of ground.

Some very good questions.

Appreciate your being with us, and we look forward to continued dialogue going forward.

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.