3M (MMM) 2013 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, Thursday, April 25, 2013.

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

Thank you, good morning everybody.

I'm here with Inge Thulin today, 3M's President and Chief Executive Officer, and David Meline, 3M's Chief Financial Officer, and thanks for joining our first-quarter business review.

Note that today's earnings release and slide presentation accompanying the call are posted on our investor relations website at www.3M.com under the heading quarterly earnings.

Also note that our next two earnings conference calls are set for July 25 and October 24.

In addition, we will post an investor meeting on the afternoon of Tuesday, December 17, at the Grand Hyatt Hotel in midtown Manhattan.

For now, block off 1.00 PM to 5.00 PM on that day if you would.

If you would please turn to Slide 2. During today's conference call we will make certain predictive statements that reflect our current views about 3M's future performance and financial results.

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

Item 1-A 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 now I'll turn the call over to Inge, and please turn to Slide 3.

Thank you, Matt and good morning everyone.

I appreciate you joining us this morning.

Overall, this was a good quarter for 3M.

We delivered solid results in the face of a stronger US dollar and lower factory utilization in a few businesses.

Double-digit organic growth in China, Latin America, and Middle East/Africa helped us overcome weakness in Western Europe and Japan.

I'm pleased that we posted sales growth of around 2% against a backdrop of 0.8% worldwide IPI.

Four of our five business groups achieved positive organic sales growth in the quarter.

Health Care posted a 4% gain in organic local currency, as did consumer, coming off a very strong Q4.

This is the first quarter of reporting based on our new structure, and as a result, we have clearer visibility on all of our business groups.

Let me make a comment on the importance of this change to the Electronics and Energy business group.

Here, the new structure not only gave us better visibility but also set the stage for better asset utilization in the future.

We are seeing early progress today and I know that we will see even more as this team takes shape.

On the customer front, Electronics and Energy creates for us a launching pad from which we can quickly introduce a broader range of technologies into the market.

And fully capitalize on the outstanding customer relationships 3M has earned in this space.

In other words, it creates opportunity.

So Q1 gave us many things to be happy about.

That said, I want to be clear that we view this quarter in a much longer and much larger context.

We will continue to manage 3M for the long term and for the sustained success of the Company.

That approach is clear when you look at our ongoing investments to improve the business.

For example, as we told you last November, we are increasing our investments in research and development and intend to be closer to 6% of sales at the end of the five-year planning period.

We continue with capital investments to improve productivity and grow the business.

We remain on track for CapEx investments of $1.6 billion to $1.8 billion this year.

We are building new strength in emerging markets and in a number of push forward businesses like Health Care, we are adding resources and on-the-ground expertise.

In summary, we are moving forward on all fronts.

We will be pushing hard to take advantage of any recovery in the second half.

Note that we have not adjusted our expectation on the organic local currency growth, which remains at the 2% to 5% for the year.

We remain focused on driving growth everywhere.

Now, let me take you through a quick look at Q1 results.

EPS was $1.61, up slightly year over year.

Operating margins were 21.6% on GAAP basis, basically flat year on year, and up sequentially consistent with historical patterns.

Four of our five business groups came in above 21%.

Excluding the effect of acquisitions, margins were 22%, very strong.

Sales were $7.6 billion, up 2% in dollar terms, and a record first quarter for us.

Organic local currency growth was up 2.1%, with Health Care and Consumer up 4%, Industrial up 3%, and Safety and Graphics up 2%.

Geographically, Latin America/Canada was up 7%, the United States and Asia Pacific were up 2%, and Europe/Middle East/Africa down 1%, with Western Europe the main area of challenge.

Currency had a negative effect on sales of almost 2% in the quarter and acquisitions added about the same amount.

Finally, in the quarter, we returned $1.25 billion of cash to shareholders via dividends and share repurchases.

The first quarter validated our previous view about the beginning of this year.

As you recall, we anticipated continued uncertainty and slow growth in the first half of the year, especially in the electronics space and that is exactly what we saw.

Today, as we look back at Q1, and forward to the rest of the year, we see reason to adjust our guidance in the interest of credibility and clarity.

Two primary factors are driving this decision.

First, macroeconomics.

The economy remains uncertain and external forecast have declined a bit since the year end, the developed economies in Western Europe and Japan in particular.

On a market level, consumer electronics continue to present challenges.

While there are some indications of an upturn later in the year, our optimism is tempered by the current reality.

We expected a challenging start to the year, but in fact market conditions were tougher than we had expected.

Second, the stronger US dollar.

We previously anticipated that 2013 currency effects would be neutral to sales and earnings.

We now expect a 1.5% sales headwind and a $0.05 per share earnings impact for the year.

The recognition of this realities leads us to an EPS outlook for the year of $6.60 to $6.85 per share.

In the quarter, we announced 3M's 55th annual dividend increase, an increase of 8%.

In addition we announced a new share repurchase authorization of $7.5 billion.

I will now turn the call over to David for more color on the quarter.

David?

Thank you, Inge.

Let's begin with Slide number 6 where I will break down the first-quarter change in sales.

Organic local currency growth was 2.1%, against a challenging economic backdrop as Inge mentioned.

In fact, the most recent forecast from Global Insight calls for a 0.8% worldwide IPI growth in Q1.

Volumes contributed 1.7% to our growth, and selling prices increased 0.4%.

Acquisitions added 1.7 points to sales growth in the quarter.

Three deals contributed to this growth, Ceradyne in our Industrial business, FS Tech in Safety and Graphics, and CodeRyte in Health Care.

Foreign exchange impacts reduced sales by 1.8 percentage points in the quarter, due in large part to a 14% devaluation of the Japanese yen versus the US dollar.

In dollar terms, worldwide sales grew 2% versus the first quarter of 2012.

On a geographic basis, Latin America/Canada led the way again this quarter with organic local currency growth of 7.3%.

And all five of our businesses posted positive growth in that region.

In particular, Health Care and Safety and Graphics grew double digits.

In the United States, organic local currency growth was 2.3%, led by a 5% increase in the Consumer business.

We also generated positive growth in Industrial, Safety and Graphics, and Health Care.

Asia-Pacific grew nearly 2% organically in the first quarter, China/Hong Kong grew by 10% in Q1, and Japan declined by 8%.

In EMEA, or the combined Europe/Middle East and Africa, first-quarter sales declined 0.8% on an organic local currency basis.

Health Care generated low-single digit organic growth in EMEA, Industrial was flat, and the three other businesses declined year on year.

On a regional basis, we achieved solid organic growth in both Central East Europe and Middle East/Africa, and Western Europe declined 3%.

Let's move to the income statement, please turn to Slide number 7. First-quarter sales were $7.6 billion, up 2% in dollar terms.

Our gross profit percentage was a strong 48%, equal to last year's comparable quarter.

SG&A spending rose in line with sales and we increased R&D investments by 5% year on year to $430 million.

Operating income increased nearly 1% to $1.6 billion.

GAAP operating margins were 21.6%, down 20 basis points year on year; included in these results was a 40 basis point headwind from acquisitions, therefore underlying margins increased 20 basis points in Q1 to a solid 22%.

Profit leverage on organic volume growth added 20 basis points to first-quarter operating margin and lower year-on-year pension and OPEB expense added another 60 basis points.

The combination of lower raw material costs and higher selling prices added 90 basis points to first-quarter margins.

Lower factory utilization reduced margins by 1 percentage point, largely related to excess inventories in pockets of our Electronics and Energy and Industrial businesses.

First-quarter earnings were $1.61 per share, up 1.3% versus the first quarter of 2012.

One more item which is not on the chart relates to our corporate and unallocated segment.

You will see a first-quarter expense in corporate and unallocated of $74 million, which is a $64 million improvement year on year.

Pension and OPEB expense declined, which accounts for 50% of that improvement.

Part of the remainder relates to our ERP project.

Now that we are moving from the development stage into deployment, more costs are being borne by the businesses rather than corporate.

On average, this reduced operating margins in each of our businesses by approximately 30 basis points in Q1, with the benefit coming in corporate.

We expect this 30 basis point margin impact to each of the businesses to continue throughout 2013.

For the full-year 2013, we anticipate a total expense in corporate and unallocated of approximately $350 million to $400 million.

Now let's turn to cash flow, turn to Slide number 8. First-quarter operating cash flow rose by $166 million or 20% to nearly $1 billion.

Cash flow benefited from $269 million of lower pension and OPEB contributions, offset in part by higher tax payments.

We invested $324 million in capital expenditures during the first quarter, up $63 million versus first quarter of last year and are projecting $1.6 billion to $1.8 billion for the full year 2013.

Free cash flow rose by $103 million or 18% to $670 million.

Free cash flow conversion was 59%, a 9 point improvement versus the first quarter of 2012.

First quarter is typically our seasonal low point for free cash flow conversion and improves as the year progresses.

We returned $1.25 billion to shareholders in the first quarter, comprised of $440 million in cash dividends, and $805 million of gross stock repurchases.

For the full year, we are now tracking towards $3 billion in gross share repurchases, which is at the high-end of our previously expected range of $2 billion to $3 billion.

Let's review in more depth our first-quarter performance on a business-by-business basis, starting with Industrial.

Please go to Slide number 9. First-quarter sales were $2.7 billion in Industrial, up 3% on an organic local currency basis, against a tough 7% comp in Q1 of 2012.

Most of Industrial's businesses grew organically in the first quarter.

Aerospace again grew double digits due to the combination of market share gains and strong end market growth.

Industrial adhesives and tapes, which is 3M's largest operating division, had solid organic growth in the quarter as did the personal care business.

Organic sales declined in our advanced materials business.

Automotive OEM grew 2% organically in the first quarter versus a 1.5% estimated decline in Q1 global auto production.

We continue to gain relevance and higher penetration levels in this massive market.

On a geographic basis, organic local currency sales in the Industrial business rose 6% in Latin America/Canada and 4% in both APAC and in the United States.

Organic sales were flat in EMEA, with broad-based declines in Western Europe, offset by double-digit increases in Central Eastern Europe and in Middle East/Africa.

The Ceradyne acquisition added 3.6% to this quarter's growth in Industrial.

Integration is progressing very well with newly combined technical teams working to identify a number of future growth opportunities.

We are injecting lean throughout the operation to drive maximum efficiency and capture value quickly.

Profits are ahead of plan while sales were short of plan in the first quarter, largely defense-related, where sales in the Industrial parts of the business are on track.

We were encouraged in March when Ceradyne was awarded a $40 million-plus order from the US government for small arms protective insert armor plates for the government of Afghanistan.

First-quarter operating income was $576 million and reported margins were 21.5%.

Ex-acquisitions, Industrial operating margins were 22.5%.

Now let's move to Safety and Graphics.

Turn to Slide 10.

First-quarter sales were $1.4 billion, up 2.3% on an organic local currency basis.

This growth was led by our commercial graphics and architectural markets businesses.

We also posted positive organic growth in building and commercial services, personal safety products, and roofing granules.

The traffic safety and security systems business posted an organic sales decline in the first quarter, largely due to weak government funding levels and a slow start to the US construction season.

We also restructured part of the business in Q1 to improve its competitiveness going forward with associated costs of $4.5 million in the quarter.

On a geographic basis, organic local currency sales rose 10% in Latin America/Canada, 4% in Asia-Pacific, and 3% in the United States.

Organic sales declined 4% in EMEA.

The FS Tech acquisition added 2.2% to growth in the quarter and integration efforts are tracking well versus our expectations.

This business also secured a major contract during the quarter for highway tolling with the Bay Area Transportation Authority in San Francisco.

Operating income in Safety and Graphics increased slightly to $335 million, and operating margins were a strong 23.7%.

Excluding acquisitions, first-quarter operating margins increased 20 basis points to 24.3%.

Next up is Health Care found on Slide 11.

Health Care sales totaled $1.3 billion, up 4% on an organic local currency basis.

We grew organically across the Health Care portfolio with particular strength in food safety, critical and chronic care, and health information systems.

On a geographic basis, Latin America/Canada grew 12%, Asia-Pacific grew 7%, EMEA grew 3%, and the US grew by 2%.

In developing markets, Health Care grew 13% on an organic local currency basis with notable strength in India, Middle East/Africa, Brazil, Central East Europe, and Southeast Asia.

Developing markets represent 25% of our Health Care sales today and a significant opportunity for tomorrow.

In developed markets, the business grew 2% organically, including 6% in Japan.

Operating income rose 1% to $404 million and margins were 30.8%, down 60 basis points year on year.

Starting January 1 of this year, we began absorbing additional costs related to the US medical device tax.

The first-quarter cost was just over $5 million, representing a 40 basis point drag on Q1 worldwide operating margins.

For many years, our Health Care business has grown organically, each and every quarter with consistently outstanding margins.

The business generates tremendous value for our customers and for shareholders.

Please turn to Slide number 12.

In Electronics and Energy, sales were $1.3 billion for the quarter, down 2% in organic local currency terms.

Growth was slightly positive on the Energy side of the business, with strength in electrical markets offset in part by weakness in telecom and renewable energy.

Electronics, which is 60% of the segment, declined about 4% organically.

Lower market demand also triggered sizable inventory reductions by some of our OEM customers and their tier suppliers.

As a result, our factory utilization ran lower than we had been expecting and we expect this will persist into the second quarter.

From an electronics end market standpoint, we are expecting a second-half recovery for three primary reasons.

One, inventory should be in good shape after Q2.

Two, wafer starts and capacity utilization are gradually increasing.

And three, the semiconductor book to bill is indicating an upward trend.

Operating income in Electronics and Energy declined 16% year on year to $196 million, and margins declined 2.4 percentage points to 15.3%.

Lower volumes in utilization were the primary drivers, here.

Finally, let's review the Consumer business found on Slide number 13.

Sales in consumer were $1.1 billion this quarter, up 4% on an organic local currency basis.

All of our businesses delivered positive local currency organic growth this quarter, with particular strength in the consumer health care, DIY, and home care businesses.

From a geographic perspective, organic sales growth was 8% in Asia-Pacific, and 5% in the US, and in Latin America/Canada.

EMEA declined 6%.

In developing markets, the Consumer business grew 9% in organic local currency in Q1.

Consumer is one of our most significant opportunities in developing markets, as the middle class is growing rapidly in many of these countries and retail is growing with it.

RIMs global capability and local presence around the world gives us a distinct advantage in serving those retail customers.

Quarterly operating income was $237 million in Consumer, equal to the first quarter of 2012, and margins were 21.9% for the quarter.

Margins declined 40 basis points year on year, due to higher investments in areas such as e-commerce, design, and advertising and merchandising.

So that concludes our review of the first quarter.

Now I will turn the call back over to Inge.

Thank you, David.

Before we go to your questions, I wanted to update you on our progress in several areas.

First, portfolio management.

On the Q4 call I referred to actions to consolidate our traffic safety systems and security systems businesses.

These restructuring actions were completed in the quarter with associated costs of $4.5 million in the quarter.

The point here of course is that we are directly addressing the more challenging segments of our portfolio.

You should also know that we are increasingly directing a larger percentage of resources towards our heartland and push-forward businesses.

Second, a word on Ceradyne.

As David mentioned, the integration of Ceradyne is progressing very well and profits are ahead of plan.

I'm excited about the emerging technology synergies from our newly strengthened ceramics platform.

Finally, we announced new leadership in APAC region.

Our new area Vice President of Asia-Pacific, Jim Bauman, has successfully managed a wide range of businesses and functions across the Company, and has extensive international experience.

He is a proven leader.

In addition, Kenneth Yu, the energetic long-time Head of 3M China will now be applying his impressive business building skills in developing markets around the world.

The new leader for 3M China is China is [Donna Chung], who most recently led and developed our business in Southeast Asia very successfully.

Donna is another great builder of businesses and the ideal new leader to implement our new China plan.

So our history of very strong leadership in APAC region continues.

To wrap up, we remain confident looking ahead and are keenly focused on elements within our control, advancing our long-term strategic objectives, driving productivity, and improving the business.

3M's unique combination of technology strengths, manufacturing excellence, and global capability will enable us to deliver sustainable increases in sales, earnings, and cash flow.

As I said earlier, we are moving forward on all fronts.

Thank you.

We will now address your questions.

(Operator Instructions)

Steven Winoker, Sanford C Bernstein & Company.

Just so I understand, how are you thinking about the cadence of I guess what is an implied 2% to 6% topline growth for the rest of the year?

You've mentioned a lot of different dynamics going into that, but if you'd take us through the quarters and how you're thinking about that, or just to say how you're thinking about that ramping up, that would be helpful.

Sure.

So if you look at how we think the quarters are going to develop, Steve, we think that it's really looking to us more like the first-half, second-half story right now.

So we think that the second quarter specifically in the Energy and Electronics is going to run in a similar fashion to what we saw in the first quarter, followed by an improvement in that segment in the second half.

And then likewise if you look at the other businesses, we are observing that we will expect to see some level of improvement in the second half.

Okay, and then could you also maybe just go through a little bit more of expectations or what you're seeing in China in terms of stocking levels and liquidity across the different businesses?

Yes.

If you look at China, first of all I would observe that we saw a 10% organic local currency growth again here in the first quarter.

And if you take that and separate Electronics and the balance of the business, we ran at 8%.

So if you think of base business at 8% in China versus it was at 10% in the fourth quarter of last year, so viewed pretty steady.

And then you saw a decline in the Electronics, and in this case Energy segment, including renewable, that caused the total growth in China to go from 16% to 10%.

So we are seeing part of the Electronics issues that I referred to in Energy are based in China, as they have a big renewables business there.

So we saw a decline in that area, which we expect will continue into the second quarter, whereas in the base businesses, Industrial, for example, and Safety and Graphics ran at 10% and 11% respectively, which is very consistent with what we saw as we finished the year last year.

This is Inge, I think on the growth piece, the way I think about it is, this is the second quarter now where we have showed growth.

And the 2% growth in this quarter, based on the IPI growth, we feel okay with.

Now, that is one of the reason -- you said 2% to 6%, we are saying 2% to 5% in the growth range for the year.

So not 2% to 6%, 2% to 5%.

And we don't change that because we're coming off the growth quarter of 2%.

Second quarter as David said looked very much like the first quarter.

Relative to China, it's good to see we had growth in Q4.

We had 10% growth in Q1 coming out of three quarters earlier of basically no growth.

Now, we believe still it's fragile in China when you look upon external data, and in Q2, it could sidetrack based on growth.

Right?

So we are optimistic, but we still need to see more evidence of growth coming in that market.

Great, thanks a lot.

I will hand it off.

Scott Davis, Barclays Capital.

Obviously, I think you're going to get a lot of questions just on growth and such, and 2% is a lot better there we're seeing in other companies.

But still in that regard when you think about taking the CapEx numbers the way you have, I think it is about a 24% increase quarter over quarter.

What types of -- maybe you can give us some examples of what types of growth, projects you're working on or what type of end markets are you expecting that type of -- the growth that would justify really ratcheting up spend in a low-growth environment?

Well this is Inge.

As we said, we are not changing the guidance for this year relative to the CapEx.

And as we all know, the CapEx investment is based on long-term growth.

So that is why we are saying, this is something we will continue, and of course there are some markets that are doing better that need more investment than over time some is more of a challenge.

But [for M] we would like to build out very much close to the market in international as we have talked about earlier.

So without going into specific segments, per se, you can think about it as we build out our Health Care business on a global basis, we are doing very well in Health Care.

We are growing well now as David referred to, the business where we are growing everywhere both from a business unit perspective and division and on a geographical base.

And we need to build that out as we move ahead, that portfolio is basically 75% in developed economies.

So the developing world is huge upside for us with very attractive margins.

So you will probably see over time additional investment in that area.

In many cases in order to be successful in Health Care, you need to be very local in order to provide that services.

The same goes for Consumer.

Consumer is another business group for us that are performing very well and our relative penetration in developing world is much, much lower than in the developed.

And specifically versus United States, that is another business over time that we will build out.

So I think you will see that.

And then you have to think about one of the strengths for 3M is our vertical integration in the business model, that means that we will utilize a lot of capacity and places around the world when we build this out.

So I would say to think about it as we are not changing it now because we invest for the future, and the future we still believe in the plan we have laid out.

And so it's looked very favorable for us.

Nigel Coe, Morgan Stanley.

Yes, so if I look at your full-year guidance, obviously maintained the full-year 2% to 5% organic.

You've got I guess a bit of modest margin expansion, maybe flat margins for the full year, flattish anyway.

Given the 1Q performance and since you still have some of these headwinds on utilization in the second quarter, you've got pretty tough comps coming up in 2Q, 3Q.

Are you confident you can maintain flat margins for the full year?

Sure.

Yes.

Yes, from what we can see now, if you look at the headwinds and tailwinds that we see for margins for the year, Nigel, certainly as we knew would be the case, we have some positives in terms of margins year over year in terms of the pension and OPEB expense.

As you would note in the first quarter, we did see continued benefits in our margins from raw materials and pricing.

So although we've indicated we think that in our planning that, that would moderate rate through the year, certainly it is notable in terms of supportive of margins.

And I think importantly, if you look at the headwinds there, we do have some higher level of integration costs of the acquisitions, which we did late last year.

So those are hitting more heavily in the first quarter.

So that will tend to subside through the year.

And then finally utilization.

And the utilization piece, there are several areas where we have under-utilization in the quarter.

One of them is in the filmmaking equipment, so if you think about the fact that the renewable energy business has seen quite a substantial downturn, there is inventory adjustments going on in that space that we think will have the biggest impact here in Q1 and to a certain extent still in Q2.

If you think about filmmaking for Electronics, as we mentioned likewise there, we see inventory adjustments that have been taking place in Q1, which we think, by the mid year, those will be have been completed, and so we will see a better utilization pattern in that area.

And then finally, we do mention Industrial, and you have some specific areas of Industrial, some materials that we make that are specialty materials that go into areas like high-performance gaskets that are used in automotive products, where they have had an inventory correction which now we see that actually has -- will have been completed here by April.

So we see those areas which will enable that under-utilization to be addressed, and that is obviously supportive of margins as we go forward.

So in summary, as we entered the year, we felt good about our ability to continue to deliver both growth and margins, and we continue to believe that is the case.

Okay no, that is really helpful.

And a follow-on, I just want to tackle Scott's question from a slight different angle.

2.1% organic growth is actually one of the better ones we've seen so far.

But you mentioned that growth is coming in weaker than expected and that continues into the second quarter.

And I'm wondering to what extent you've manage discretionary costs a bit tighter than maybe envisioned or whether that's an option you can use as we go into second quarter and the second half of the year?

Sure.

So what I would say is that as we entered the year, we were quite cautious, not dissimilar to how we operated the business throughout basically the entire 2012.

And so we've been managing costs quite cautiously through last year, through the first quarter, and frankly, we are in a position now where we will continue to do that until such time that we see our growth picking up more strongly, which would support incremental investments in certain areas.

At the same time, and I think it is apparent and hopefully you've picked up from some of our comments here, we have no intention of backing off the investments that we believe are appropriate for the long-term health of the business.

So whether that be building out this emerging and developing market presence.

Whether that is building out our capabilities with our systems as I talked about, which are significant commitments we are making, ramping up the R&D with a particular focus on the innovation area for some of these longer-term breakthroughs.

We have the capability to do that and we expect to continue that.

Okay, thanks, David.

Andrew Obin, Bank of America Merrill Lynch.

Just a question on your outlook cut.

So we said that $0.05 is FX, but we've left the organic growth untouched.

So how should I be thinking about the remaining $0.05 cut, is it margin Electronics, what is it?

Yes, basically, Andrew, what we are signaling with that -- with the overall cut is, frankly, a level of uncertainty overall in the business that is a little bit higher than we had when we entered the year.

So first of all, we've identified specifically $0.05 due to exchange, but quite honestly, to pick a point estimate on that number is a little bit difficult to develop that level of precision, but I think directionally we tried to size that impact for people so they could understand it.

And the balance of the cut is really reflecting what has turned out to be some areas of incremental weakness in the business here in the first quarter and the first half, particularly related to the areas in Energy and Electronics we mentioned.

So I would take it as an indication directionally that we think there is more uncertainty out there overall this year than perhaps we expected as we entered the year.

Just so I understand Ceradyne, I guess in your waterfall chart you highlighted margin drag from M&A.

You've also noted that sequestration was a drag, but you've also stated that Ceradyne is performing ahead of your expectations.

So how do I reconcile that?

Yes, so a couple of things.

So if you look at, first of all, the impact that would impact us from sequestration is, first of all -- if you think about our business overall, we've got about 3% of our worldwide sales are related to the US government, that's at federal, local, and state levels.

And about 40% of that, which is $1 billion, is related to federal.

So we think that the sequestration impact for us would be somewhere in the area of $10 million to $20 million on the year, and that would likely be here in the second and third quarters, and we are working to offset that with market share gains.

Separately, if you look at what is going on with Ceradyne, there is an additional impact.

So if you look at what is going on with troop drawdowns, that would impact Ceradyne's revenue we calculate in the tune of $40 million to $50 million.

And so again we are working on offsetting that.

This contract that we were able to win for $40 million in the -- as it relates to body armor for the Afghanis is offsetting that.

And secondly we've got a series actually last count, I think there are 27 sales synergy programs that the guys have identified with existing and new products from Ceradyne that we can push through our channels around the world for 3M.

So a couple of separate issues.

If you look at the income of Ceradyne as we said, while we've got transition costs that are pulling through, the income statement including inventory step up, which still hits us in Q1, we do see that the overall performance on an income basis versus our original acquisition plan for Ceradyne is running ahead of the plan.

Thank you very much.

Ajay Kejriwal, FBR & Co.

Maybe a clarification on pricing, raws, the comment -- Do you expect that spread to moderate from here or was that more a comment on pricing?

And also what you expect on raws, it looks like it was a nice tailwind here.

Yes, so right, so in the quarter we had 0.9% favorable impact on our margin year over year, a combination of both price and raws as you know Ajay.

And if I just take the pieces, first of all on pricing, as we entered the year, we expected to see relatively minimal benefit from pricing through the year.

And in fact Q1 was a little bit better than we expected.

As I look at the year on pricing, I would say it is still early for me to think about adjusting my view on pricing for the year.

And if I looked at raw materials, likewise, we did benefit in the first quarter from continued tailwinds from lower raw material costs.

We had said for the year we felt we would have a plus or minus $0.05 impact as a result of raw materials.

And quite honestly, there, it depends very much as to the direction of the economy as to how that one is going to play out.

Got it.

And then on the underutilization of capacity, it we've seen that for a couple of quarters.

It looks like it continues into Q2.

And I know you talked about a second-half pick up, but I guess the question is on the excess capacity.

Are you positioning yourself for that uptick or should we expect some capacity rationalization here?

Yes, it's a good question, Ajay.

So what I would say is the particular area that we've called out here, is in the Energy and Electronics business.

And what you see happening is that we put those businesses together with a very specific intention to better utilize our assets and more effectively across the segments over time.

So if you think about the assets that we use used to support our renewable business and our filmmaking business pointed at the Electronics space, by having those under a single umbrella, what we are already seeing now, is the guys are able to even more adeptly manage that capacity.

So in this case, as we see renewable energy, which is going through a very swift downturn, we've already made some adjustments to our capacity plans, so that we are repurposing that capacity towards other filmmaking activities.

What is also true and an example of that would be, we have a growing segment right now in the touchscreen area.

And so, we've already repurposed some capacity that we'd originally expected to be adding, we've been able to repurpose existing, point it at that touchscreen market.

So while we would not foresee right now any need to rationalize, per se, what you could see over time, which is a typical 3M type model, which is, okay, we are repurpose seeing and redirecting capacity towards another business that is growing, when we've got one that is not doing as well in the future.

Great, thank you.

Steve Tusa, JPMorgan.

On the raw mats, could you maybe clarify what was the year-over-year decline in raw mats, I think it was 3.5% in the fourth quarter.

I think you've been giving that every conference call.

So yes, that's right.

The last year in the raw materials in the second half including the fourth quarter was over 3% and a little over if you look for the full year in '12 a little over 2%.

This first quarter we saw that decline somewhat, but it was still over 2% favorable.

Okay, so it's -- sorry, the benefit declined somewhat is what you're saying?

Yes, the benefit decline, still obviously --

Got you.

And on your comment on Electronics I guess you said that you expect a similar to 2Q to 1Q.

Does that mean this similar growth rate or similar just basically steady from an absolute perspective?

Generally speaking, as we look at the Electronics outlook, what do we see?

We see a first-half, second-half phenomena, quite frankly not dissimilar to what we experienced last year.

And if I think about that first-half, first quarter, second quarter whether it be growth percentages, whether it be dollar numbers, we think that it's going to be pretty stable through the first half.

Okay, that makes a lot of sense.

One last question on --

And that is very consistent with external data that you see, right so I think that's --

(Multiple Speakers) The macro electronics.

That is also why we are very cautious right?

So we don't see it yet even if there are some hopes for the future there, so that's why we try to move it forward.

Sure.

And then lastly just you did say corporate was still guided $350 million to $400 million?

For the year that is correct.

If you look at the quarter it's a little lower because of some things that happened in Q1 of last year, we think for the year $350 million to $400 million.

So with these dynamics will you guys grow earnings in the second quarter?

Certainly, we are holding our guidance for growth for earnings for the year, $660 million to $685 million versus $632 million last year.

We saw modest growth of income in the first quarter, and quite frankly we are driving to generate earnings and growth every quarter and that will certainly include the second quarter.

Okay, great.

Thank you.

Jeff Sprague, Vertical Research Partners.

Just a few questions if I could.

Just on R&D tax credit, it didn't appear you guys had any benefit in the quarter.

Why is that and is there something that follows subsequently?

Yes, so Steve on taxes, what is true is actually the R&D, the pickup we got for the deferral of the extenders actually was beneficial to us in the first quarter by 1.7%.

So inside of that first quarter 29.1%, we did have a benefit, but what is also true is if you look at the first quarter, the underlying run rate was closer to 31% for the quarter.

Typically, our highest tax rate is in the first quarter of each year and it moderates through the year.

So we expect 29.5% to 30% for the full year, same as we'd originally set out and we think it will run fairly stable through the year.

Great.

And then just on the Japan and the yen situation, obviously the translation is understandable and a mathematical exercise.

Are there any particular export opportunities for you out of Japan that are new or different around the yen weakness that could possibly be a mitigating factor?

Let me make some comments on Japan in a bigger picture.

We have -- what is happening in Japan now, is something that we in a way could predict quite some time ago.

So we have worked in Japan as a business for quite some time.

In fact we started in the beginning of 2009 was when we took a big charge in order to reset our operations there.

And since that, we have done a lot of things in order to make sure that we would have a better competitive position in Japan.

And that has been resetting of the manufacturing footprint, we made an acquisition later as you'll recall A-One, which is into their consumer business group.

We have started to shift our resources I would say to more domestic businesses, and for us more domestic will be the Consumer business, the Health Care business, and some of the Safety businesses.

While we have really put emphasis on the local manufacturing for automotive specifically and the Electronic area per se.

So we have been working this for quite some time, and when we look upon our results in Japan, the interesting thing for us is we look now in terms of growth for Health Care for the quarter was over 6%, for Consumer over 7%.

And so we get traction there, and I think we are very well set for the future in Japan.

But it will take some time for us.

Now for them, I think when you talk about export and import in and out of Japan, this will take some time for them to get the plan working.

So we hear good things.

If you have interacted and worked with Japan over time, you also know this will take some time before that will come traction.

But generally speaking, we have a good, solid manufacturing footprint in Japan that we can capitalize on already now if it picks up for them in terms of domestic manufacturing, which is what they would like by definition.

That is what they are driving at.

Right?

And so we have in fact our biggest super hub in the world is in Yamagata, Japan.

So we have incredibly capabilities there already now to capitalize if they will take off, which we assume they will in terms of domestic manufacturing.

I hope that helps.

That does, thank you and just one other quick follow-up.

David, can you just give us some color on what the share count is implicit in your guide?

And the reason I ask is it looks like you had a lot of options exercised and everything, you actually did more than 25% of your annual buyback in the first quarter, and your share count is up sequentially.

Yes.

So what I would say, Steve, is the guidance we gave which still looks good for us is a gross buyback of $2 billion to $3 billion for the year.

And as I said earlier, we are running as you can see at the high end of that range.

And if you look at the net buyback that we called out, I think it was around $1 billion to $1.5 billion for the year.

And in fact you are right, we expect that to be towards -- the reissuance towards the high end in that there was a lot of reissuance this first quarter as we saw record share price for the Company.

So I don't know how to predict how that's going to play out, but we're continuing to maintain our view that both gross as well as net will be able to achieve the original allocation plan we set out.

Great, thank you.

Joe Ritchie, Goldman Sachs.

Just a clarification on Electronics and Energy, if we are forecasting a similar growth rate for the second quarter, even the low end of your guidance then implies roughly 4% growth in the third and fourth quarter.

And so my question is really, regarding your confidence around that and then specifically how that relates to the margins as well.

Because based on the data we have, it looks like this is the lowest margin quarter we've seen in this business over the last 12.

So would love to get some color on the trajectory of margins there as well.

Yes, maybe I can address that, Joe.

So if you look at the Electronics and Energy business, a couple of I think relative context points.

One is, as we did enter the year, we did put the widest range on sales growth of the five sectors we defined around this business, because it was our perception that there was a -- there was some uncertainty coming into the year.

So we've got if I recall 1% to 6% for the year is the range.

We continue to believe that that is a good range for the segment despite having run below that obviously in the first quarter, and we expect to run at a low level in the second.

So we do expect a pickup in the second half, which again is I think not inconsistent with indicators that you would observe elsewhere.

In terms of the margin performance for the business, as we set up the year and tried to give some indication as to how we thought that would develop, we did indicate that we thought E&E for the year would have margins below the Company's average, in fact, in the high teens.

And we continue to expect that to be true.

So I think you can infer that you will see a first-half, second-half pattern both in growth as well as the consequent margins related to that sector.

Okay, great.

And I guess one other -- one follow-up on the margins, your Health Care margins have been strong for several quarters.

Saw a bit of a downtick on a year-over-year basis, any color you could provide there on mix, that would be very helpful.

Yes, so I guess what I would say on Health Care margin, likewise we'd indicated we thought this year we would continue to run at similar margin levels as we've seen through last year, which has been 30% plus for that sector even though we think maybe long-term view is a little bit below that.

You did see it come down a little bit in the quarter year over year.

Certainly, we have identifiable aspects, one being a 0.4% impact of the new device tax on a year-over-year basis.

As I mentioned, the ERP costs that the businesses are picking up in the first quarter creates an additional 0.3% headwind on a sector margin basis in the first quarter and that will continue.

So if you think about those couple of factors in the context of the overall margin performance, I think you could and you should take away a view that we continue to believe that the business and the sector is very healthy and will run pretty stable at a high level through the year.

And in addition to that, as I made in my comments that we are giving additional investment to some of the push-forward businesses, and Health Care is of course one of them.

So we are very, very positive around the outlook for Health Care.

So we are not only pleased with current performance, in fact I would say I'm very, very pleased with current performance in Health Care, but the outlook is also very, very solid for us.

So we are supporting that business, push forward, we are moving resources very cautiously though in order to make sure we get productivity at the same time as we build out.

And most of the buildout is in developing economies, and in an international broad base, and as you know 75% of our portfolio today is in the developed world.

So as those economies now start to be ready to take on more advanced Health Care, and we have a very good value proposition with our product line, broad-based I would say in both hospital supply and in the orthodontic field, as well as in food service.

So it looks very good for us as we move ahead.

Great, thanks.

I appreciate the color.

Scott Davis, Barclays Capital.

Sorry I jumped off earlier, I had the phone on mute, my fault.

It's not my first quarter I've ever listened to calls on, but you would think it is.

(laughter)

Anyways, I wanted to follow-up on this US medical device tax.

And is this somewhat of a timing issue where it just takes you a while to pass this on to your customers, or is this something you've got to eat for a while until we anniversary it?

Yes, great question, Scott.

I guess we don't think about it as a pure pass-through that you receive a cost increase, and then you pass the price through to the market.

Our view is that we need to look at the offerings that we provide to the market.

We need to remain competitive.

We need to make sure we manage our costs so that we get a margin for our efforts.

So I don't think of them as having such a direct relationship if you will.

Okay.

And as you probably know, in that field specifically, in the Health Care field it is very difficult to pass it on because you have to pass it on then in terms of price increases.

Right?

I'm sure that could be tough.

So that is tough.

And if you look upon the price increases for Health Care as you stand into the year, they are able of course to take a little bit higher in the developing world versus in the United States.

So I think it is correct as David said is it's nothing we guys can push on.

We need however to drive efficiency in the manufacturing operations, which I would say in the Health Care space is a very effective operation for us.

Right?

So one of the reasons why we are successful there with very high margins is many things in addition to the value of the product, but it is also very good manufacturing operations.

And as you know we can always do more and we have Lean Six Sigma all over in order to improve even more.

So I think that's how we need to compensate for those type of things that we cannot control.

No, I understand.

Just a real, real quick one.

When you look across the companies that we cover, it seems you guys get a little bit more stock dilution than the average on old option plans and share offerings and share grants and stuff.

Is that -- does that start to tail off over time?

And I guess my point being, as your compensation strategies change either to be more cash based and less option-based, or is it just this is how it is and we should just model that type of dilution going forward?

No, it's a good question.

So couple of comments.

One is, if you look at on an overall basis the historical pattern of the share count, we over the last decade have seen a decline, typically on average around 1% annually.

And as we look at -- we looked into this next five-year plan that we talked about late last year, our current expectation is that decline will increase somewhat to 1.5% to 2% area going forward.

And that is a few things.

One is, as we think about how we allocate capital in that direction.

And secondly, importantly, there have been some changes to the compensation plans that have been put in place over time.

So for example in 2007, there was a change in terms of the mix of comp, which resulted in the number of options being granted to be reduced in about in 50%.

So it's a little bit like longer-term phenomenon, but we are now seeing coming to a step down in terms of the overall number of options that are outstanding and have not been reissued, the shares yet.

So and if you look at the first quarter to your comment, quite frankly, with the way the stock price performed, we saw a lot of reissuance occur then.

So we think that the total outstanding unexercised count of options probably will be cut in half by year end from where it was as recently as a few years ago.

That's very helpful.

Thanks guys.

Thanks for letting me back in the queue.

Deane Dray, Citigroup.

Thank you.

Good morning everyone.

Covered a lot of ground, just a couple of cleanup questions here.

First for David, could you update us on the currency hedging that you do have in place, and is it fair to say you've got about 50% of your yen exposure hedged?

Yes, Deane, thanks for the question.

So yes.

So we continue with the same approach that we've had in the past, which is on a rolling basis to be hedging 50% of our exposure.

So that would certainly include the yen.

I think more specifically, if I look at the pattern and we compare the impact of this devaluation on a year-over-year quarterly basis, what we do see is we called out $0.05 headwind year over year now as we move through, and that's concentrated in the first half.

So and specifically, we think we will have -- if exchange rates stayed at a similar level to where they ended these recent days, we would expect to see something akin to $0.03 to $0.04 of that impact, impacting us in Q2.

Would that also show up as your mark-to-marking these currency contracts, or would they roll off and it's a P&L impact?

They would show -- what happens is we have hedge accounting treatment on both the exposure and these matching hedges.

So that's how we are able to predict as I just described, the P&L impact in the second quarter, because we know what those unrealized gains and losses are.

And so if exchange rates are unchanged as we move forward, those contracts will be maturing throughout the year, including the second quarter.

And therefore what I am referring to is the unrealized gains and losses that we can see on the book right now.

That's real helpful.

And then just my last question for Inge, I was hoping you could update us on the portfolio review.

We've seen how you've gone through the sell fixed combined process with traffic and security being combined, but what else is on that hit list and where do you stand in that review process?

Yes, I don't know.

I don't refer to them as a hit list.

I like most of those businesses, as you know, all of them make money, all of them are good, but they are in our world, they are below average relative to performance.

We are working our way through there and I would say we take them business by business.

I've not announced a specific time line because as you know, business is not conducted in that way.

So I will let you know after we have let internally, and people know if there is some change is coming there.

But the point I can tell you, which is very encouraging is that those businesses have improved dramatically the performance in the first quarter versus a quarter ago.

So they got tougher targets and they are meeting those targets.

I think that is good.

Now, the heartland and push forward, the heartland divisions had a very good performance in the first quarter.

In fact as David said, our biggest division in the Company, Industrial, adhesive and tapes had over 7% growth, so yes fantastic, but that category is doing very well.

And push forward, I would say as that is lower leverage for us, we are allocating resources.

There is more to come in terms of execution of the plan.

Point is, we are very focused on it.

We spent a lot of time.

There are different measurement and people know it.

Right?

And I think that is the key element on how we are driving this forward.

So I'm very encouraged around it, because both myself and David and the whole Management team believe in this approach in order to improve the portfolio and the performance of the Company.

So rest assured we are on it.

And as some announcement is coming, you will know as one of the first when we have told people internally.

Great, thank you.

Laurence Alexander, Jefferies.

Just one quick one.

Within your portfolio do you have any businesses that are more leading indicator businesses for the rest of the portfolio that are not just benefiting from an inventory swing in the channel but are actually are improving enough to give you confidence on the back half, or is it all top-down and your historical patterns?

We probably don't look upon it product line by product line.

We follow it from the market perspective, and I would say that we have very good customer insight and interaction with customers.

So we are able to follow very well.

I think one of the advantages for us is the closeness that we have to our customers and the customer intimacy based on a lot of technologies that we are working together with them on both on platforms that they are developing, which is an indicator of when can that be launched.

Yes or no.

And also consumables in the industry.

So we can have some businesses that we will see an early uptick that is a good indication, but I would also say we are not following it that way.

We take an approach of following each marketplace if you like and get solid input, and then have those dialogues, which is a combination of external facts and data and what our teams are talking about.

So that is the answer to that question.

Thank you.

That wraps it up.

Excuse me, we ran a little late but we had a lot of questions and they were good question.

So thanks for those and thanks for joining us today.

And appreciate your listening in.

Bye bye.

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.