3M (MMM) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M third quarter earnings conference call.

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

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

(Operator Instructions)

As a reminder, this conference is being recorded, Thursday, October 24, 2013.

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

Thank you, and good morning.

Here with me today are Inge Thulin, 3M Chairman of the Board, President, and Chief Executive Officer, and David Meline, our Chief Financial Officer.

Welcome to our third quarter business review.

Note that today's earnings release and slide presentation accompanying this call are posted on our Investor Relations website, at 3M.com, under the heading Quarterly Earnings.

Before we begin, I'd like to address a few upcoming events highlighted on slide number 2. First, we have set the dates for our 2014 earnings calls.

They are January 30, April 24, July 24, and October 23.

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

We plan to have several presenters on hand for this event, including many members of our senior leadership team.

Inge will provide the keynote presentation, highlighting 3M's progress on key strategic initiatives and objectives, and the heads of our five business segments and international operations will highlight their respective businesses.

Finally, David will provide a status update to the five-year plan that we introduced in November of 2012, including capital structure and capital allocation.

And of course, we will articulate our 2014 earnings outlook.

Invitations for this event will be sent this afternoon, so please RSVP as soon as possible and we hope to see you there.

Please turn to slide number 3. 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 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions.

So let's begin today's review.

I will turn the program over to Inge, and please turn to slide number 4.

Thank you, Matt, and good morning, everyone.

As always, I appreciate you joining us today.

I am pleased to report that Q3 was a strong quarter for 3M.

We posted an all-time record for quarterly sales and every business grew sales organically.

All five business groups posted margins above 20%, while we continued to advance our strategic priorities and investments.

Let's take a look at a few third quarter highlights.

Sales rose 5.6%, to a record of $7.9 billion.

Organic local currency growth was 5.8% in the quarter, led by Safety & Graphics at 8%, Health Care at 7%, and Industrial at 6%.

Our Consumer business grew 4% organically, as did Electronics & Energy.

This quarter's organic growth of 5.8% was a significant improvement versus the 2% growth in the first half of 2013.

Industrial, Safety & Graphics, as well as Electronics & Energy showed the most improvement.

On a geographic basis, developed economies, such as United States, West Europe and Japan, also showed substantial improvements.

On a year-to-year basis, we posted positive organic growth in all geographical regions.

Latin America/Canada led the way, with double-digit organic growth of 11%.

Asia-Pacific rose 7%, the United States went up 5%, and Europe/Middle East/Africa increased 4%.

As expected, currency was a headwind to sales, reducing worldwide sales by 1.7%.

And acquisitions added 1.5 points to third quarter growth.

So all in all, a very strong quarter, with organic local currency growth of 4% across all developed markets and 10% in developing markets.

Operating margins were again strong at 22%, or 22.4% excluding the first-year impact of acquisitions.

All five business groups deliver margins above 20%, while also growing their top lines, proof of continued broad-based effectiveness and efficiency.

Earnings were $1.78 per share, up nearly 8% versus third quarter of 2012.

Finally, we returned $2 billion to shareholders in the quarter through dividends and share repurchases, or $4.8 billion through nine months of the year.

In summary, it was an excellent quarter for 3M on many fronts, and our businesses continue to grow very profitably.

I thank the 3M team for their outstanding effort to deliver these very good results.

Let me now review the outlook.

Please turn to slide number 5. With one quarter remaining in the year and the business performing to our expectations, we are narrowing our full-year guidance to $6.65 to $6.75, versus a previous range of $6.60 to $6.85 per share.

On organic local currency growth, we are also narrowing the full year 2013 range to 3% to 4%, versus the previous expectation of 2% to 5%.

We continue to expect that currency impacts would reduce sales for the year by approximately 2%, and we look for acquisitions to add about 1.5% to sales for the year.

As for the 2013 tax rate, we now anticipate the range of 28% to 28.5%, and free cash flow conversion is expected to be approximately 90%.

Now David will take you through the details of the quarter.

David?

Thank you, Inge.

Let's begin with a review of sales growth.

Please turn to slide 6. Organic local currency growth was 5.8% in the third quarter, which was a significant acceleration versus the 2% we saw in the first half of the year.

Volumes contributed 4.8% to third quarter growth and we continued to see good pricing power, with selling prices up a full percentage point year-on-year.

Acquisition added 1.5 points to sales growth in the quarter, related to Ceradyne in our Industrial business and FSTech in Safety & Graphics.

Foreign exchange impacts reduced sales by 1.7% points in the third quarter.

Currency impacts were negative 6% in Latin America/Canada and negative 5% in Asia/Pacific, while EMEA had a positive 3% currency impact year-on-year.

Third quarter sales rose 5.6% in dollar terms.

Looking across geographic regions, Latin America/Canada led the way, with strong organic local currency growth of 10.5% in the quarter.

All five business groups contributed to growth in the quarter, including double-digit organic growth in Industrial, Health Care and Safety & Graphics.

Asia-Pacific grew nearly 7% organically in the quarter.

China/Hong Kong grew by 11% in Q3, with notable strength in Safety & Graphics and in Health Care, followed by Electronics & Energy.

Organic local currency growth was 5% in Japan led by Industrial, Health Care and Consumer.

Organic local currency growth was 4.5% in the United States.

Health Care, Industrial and Safety & Graphics led US growth in the third quarter.

In EMEA, organic local currency sales growth was 4.3%.

West Europe was up 3% year-on-year, continuing a positive trend.

This was our strongest growth in West Europe since the first quarter of 2011.

Middle East/Africa increased double digits, and Central and Eastern Europe also posted good growth in the quarter.

Organic local currency growth was 4% across all developed markets, a positive step up versus recent quarters, and 10% in developing markets.

Let's turn to slide number 7 for a discussion of the third quarter income statement.

Sales rose 5.6% to $7.9 billion, which is the highest quarterly sales result in 3M's history.

We generated $3.8 billion in gross profit, and gross margins increased 10 basis points year-on-year to 47.6%.

SG&A and R&D investments rose 8% and 6%, respectively.

Operating income increased 3.6% in Q3, to $1.7 billion.

GAAP operating margins were 22%, down 40 basis points year-on-year.

Included in these results was a 40-basis point impact from acquisitions; therefore, underlying margins were equal to last year's third quarter result.

Leverage on organic volume growth added 40 basis points to operating margins in the third quarter, and the combination of lower raw material costs and higher selling prices added 1.2 percentage points.

Strategic investments and one-time actions reduced margins by 80 basis points year-on-year.

This represents incremental investments in disruptive R&D, our ERP system, and restructuring actions.

Foreign exchange impacts reduced margins by 30 basis points, and the combination of the US medical device tax and other factors negatively impacted margins by 50 basis points year-on-year.

Third quarter earnings increased 8%, to $1.78 per share.

Foreign exchange impacts hurt EPS by $0.04 versus the third quarter of 2012, and a lower tax rate added $0.02.

Average diluted shares outstanding declined 2% year-on-year, which added $0.03 to EPS.

Now let's turn to cash flow.

Turn to slide number 8. We generated $1.2 billion of operating cash flow in the third quarter.

Working capital investments were higher year-on-year, largely timing-related, and we expect that they will reverse in the fourth quarter.

Capital expenditures were $404 million, an increase of $46 million versus last year's third quarter, and we expect full-year CapEx will be in the range of $1.6 billion to $1.7 billion.

Free cash flow was $747 million, and we converted 61% of net income for the quarter.

For the full year, we anticipate free cash flow conversion will be around 90%.

We paid $431 million in cash dividends during the quarter, or $1.3 billion year to date.

If you looked at our balance sheet in today's press release, you would see that the worldwide cash and marketable securities are $1.6 billion lower today than one year ago.

We are managing the business with lower cash levels, the US in particular, for several reasons.

First, the business continues to grow and generate significant cash flow.

Second, rising interest rates are positively impacting our already well-funded pension status.

And finally, our capital structure remains very strong, which is an important component of our business model, but we do not intend to strengthen it further.

Gross share repurchases during the quarter were $1.5 billion, and for the reasons cited above, we are increasing our expected range to $4.5 billion to $5 billion, versus a previous range of $3.5 billion to $4.5 billion for the year.

And as Matt mentioned, we will provide a full planning update at our upcoming Investor Meeting in December, including capital structure and capital allocation.

Now let's review our third quarter performance on a business-by-business basis.

Please go to slide number 9. Our Industrial business had a good third quarter, with sales of $2.7 billion and 6.2% organic local currency growth.

The growth was broad-based, as all operating divisions and all geographies posted positive growth.

Our Aerospace and Automotive OEM businesses generated double-digit organic local currency growth, and we also saw strong growth in Advanced Materials, Liquid Filtration, Automotive Aftermarket, and Industrial Adhesives and Tapes.

On a geographic basis, organic local currency sales rose 13% in Latin America/Canada, 8% in EMEA, 6% in the US, and 3% in Asia-Pacific.

The Ceradyne acquisition added 4.1% to growth in the quarter.

Integration is going very well and profits continue to exceed expectations.

Nine different 3M divisions have launched development projects that leverage Ceradyne technology.

First-year sales are a bit short of plan, due to US troop draw down efforts, but we are winning new business with customers.

In September, for example, we earned an $80 million contract to supply enhanced combat helmets to the US Marine Corps.

Third quarter operating income was $568 million and reported margins were 21.3%.

Excluding Ceradyne, Industrial operating margins were 22.2%.

Margins were also impacted by negative FX and strategic investments in growth programs and our ERP system.

Please turn to slide number 10.

As expected, our Electronics & Energy business rebounded nicely in the third quarter compared to the first half of the year.

Sales were $1.4 billion, up 4% in organic local currency terms, and operating income rose 3% to $300 million.

Margins were 20.7%, up a bit versus last year's third quarter and up 3 percentage points sequentially.

Electronics-related sales increased 4% on an organic local currency basis.

Market demand was stronger year-on-year, and we were spec'ed in to a number of newly introduced electronic devices.

Most industry sources are projecting flat demand for electronics this holiday season.

As a result, we are planning conservatively through year-end.

On the Energy side, organic local currency growth was 3%.

Electrical markets led the growth, boosted by record sales of our ACCR overhead power conductor.

Communications and Renewable Energy were both slightly positive year-on-year.

On a geographic basis, organic local currency sales increased 6% in Asia-Pacific, 3% in Latin America/Canada, and just slightly in EMEA.

Organic sales declined 1% in the US.

Please go to slide 11.

We saw growth accelerate in Safety & Graphics in the third quarter.

Sales were $1.4 billion, up 8% organically, a significant increase from the 2% in the first half of the year.

We generated double-digit organic growth in Personal Safety Products and in Roofing Granules.

Our Commercial Graphics and Building & Commercial Service businesses also posted good organic growth in the quarter, and Traffic Safety & Security rose slightly.

Sales in Safety & Graphics grew organically in all major geographic regions, with strong double-digit growth in both Asia-Pacific and Latin America/Canada.

The FSTech acquisition added 0.9% to growth in the quarter.

Safety & Graphics generated an operating income of $315 million, an increase of 7% versus last year's third quarter.

Margins were up slightly year-on-year, to 21.8%.

Excluding FSTech, third quarter 2013 operating margins were 22.1%.

Now let's look at Health Care, found on slide 12.

Sales in this business were $1.3 billion, up 7% in organic local currency terms.

As was the case in Industrial, we generated positive organic sales growth in every division and in every geographic region within Health Care.

Organic sales growth was strongest in Food Safety, Health Information Systems, Oral Care, Drug Delivery, and Critical and Chronic Care.

On a geographic basis, organic local currency sales increased 11% in Latin America /Canada, 9% in Asia-Pacific, 6% in the US, and 5% in EMEA.

And across all of the developing markets, Health Care generated 14% organic sales growth.

This is very similar to recent quarters.

Operating income was $426 million, up 7% year-on-year, and margins rose 40 basis points, to 32.1%.

Margins were helped this quarter by a gain on the sale of a small non-strategic asset, offset in part by the US medical device tax, the net of which added 1 percentage point of margin.

Our Health Care business continues to post strong and consistent sales growth and excellent profitability.

This helps stabilize the more cyclical elements of our portfolio.

The business generates tremendous value for 3M.

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

Consumer also posted a strong third quarter, with sales of $1.2 billion and organic local currency growth of 4%.

Operating income was $247 million, up slightly year-on-year, and operating margins were 21.5%.

Organic sales growth was strongest in our Consumer Health Care, Home Care, Stationery and Office Supplies, and DIY businesses.

On a geographic basis, organic local currency sales growth was 9% in Latin America/Canada, 7% in Asia-Pacific, while EMEA increased just slightly.

Organic growth was 3% in the US, helped by a good back-to-school season.

Developing markets within Consumer grew 10% organically in the third quarter.

Similar to Health Care, the Consumer business is a very steady grower with excellent profitability and is a stabilizing force within the 3M portfolio.

That concludes our discussion of 3M's detailed third quarter results.

I'll now turn the call back over to Inge.

Thank you, David.

Before we take your questions, I want to highlight our progress on three important strategic levels, portfolio management, investment in innovation, and business transformation.

First, portfolio management.

We continue to strengthen and prioritize our portfolio.

The Electronics & Energy business is a good example of where we are making progress.

In the third quarter, we consolidated the Infrastructure Protection division into the Electrical Markets division, giving this business a lower cost structure, improved market relevance and greater international reach.

Also, earlier this year we integrated Touch Systems into the Electronic Solutions divisions to align these businesses to better serve our customers.

There is more portfolio work to be done here, and we continue to look at other special opportunities.

One of the primary reasons for forming the Electronics & Energy business was to present a single 3M voice to the electronics industry.

Now we are easier to work with and more relevant to large fast-moving electronics customers; and I'm happy to report that we are receiving very positive reaction from customers on all these changes.

Second lever, investment in innovation.

Innovation remains the center of our plan, and as I hope you remember, last quarter we shared some details about how we are investing in long-term disruptive technologies with significant growth potential.

We are now funding 20 new product platforms, several of which are expected to be introduced to the market in 2014.

We are also investing in a new state-of-the-art laboratory facility at our headquarters in St.

Paul, Minnesota, which I announced last year.

We broke ground in August and construction is well underway.

This new laboratory will be an important hub for 3M's global research network.

Finally, the third lever.

We continue to make good progress with respect to business transformation in ERP implementation.

We successfully went live in Taiwan, Russia, Indonesia and Philippines, and in October, we went live in Canada.

Next up is our European/Middle East/Africa supply chain Center of Excellence in Switzerland in November.

Twenty more countries are scheduled for 2014.

We expect to achieve benefits in many areas, including supply chain, working capital management, customer responsiveness, improved business planning, and faster decision-making.

In closing, we delivered a strong third quarter with good, broad-based performance across all businesses.

We remain focused on expanding our business, driving productivity, and executing your plan with strong discipline.

I thank you for your attention, and we will now take your questions and comments.

(Operator Instructions)

Scott Davis, Barclays.

Hi.

Good morning, guys.

Good morning, Scott.

Inge, the top line growth is really coming through, and I think that supports what you've been trying to accomplish.

Can you give us a sense of how you think of this quarter as a bit of an anomaly, in that margin -- your incremental margins, at least, based on some higher costs, ERP, things like that that came through -- would you anticipate that going forward you'd show us maybe a little bit better incremental margins, or is this something that the cost of the higher growth is going to impact margins for a while until things -- until these investments really normalize?

Well, first of all, on the growth side, I am pleased.

We are pleased with the escalation we saw to the 5.8% in this quarter versus 2% in first half of the year.

And I need to give some credit here to the 3M team for doing a very good job in order to work very hard to take market share and have very specific programs in all business relative to competitive conversion.

So I think that's an important element as we see the growth coming here.

And, yes, to describe the growth in a way, if you think about it, we have had steady growth in Health Care and Consumer now for several quarters in a row.

Very steady.

It's working very well.

And this quarter, you saw Electronics & Energy turn up.

And as I mentioned that in my comments, and David commented on as well, and that is that we saw growth rate in Industrial-oriented businesses turning up in Q3 versus first half.

And that was broad-based, so it was very interesting to see.

It was Industrial Tape and Adhesives.

It was Abrasives.

It was the Automotive OEM, and it was in Personal Care.

So it was broad-based.

We saw it very much also in developed economy, which was very good for us.

So as you know, in terms of moving forward, our plan is not margin expansion, by definition.

So we are committed to the plan we laid out.

I think as you think about the balance of the portfolio, with more growth in our biggest business, which is Industrial, that had a slightly tougher comparison also versus last year.

They had a very good Q3 last year and had a peak performance in Q2 of last year.

I think you have to look upon that, when Industrial also grew as they did in developed economy, I think you will see these types of shifts in the mix.

But I think as you move ahead, we are committed to our plan.

And overall, I am very pleased that we now are able to see top line growth and maintain margins.

Just think about it.

We are delivering 22% bottom line here, 22.4% excluding first-year impact of acquisitions.

That's a very strong quarter, and I am pleased with that.

That makes sense.

Just as a follow-on, if you can help us understand -- we can see the progress on the top line.

I just want to ask the question in a slightly different way.

If you think about 2012, you finished the year with about 6% EPS growth.

2013 seems to be tracking around 6% EPS growth.

When you think about the longer-term focus of 3M -- you've turned around the growth side, and I understand you don't necessarily need to show a higher margin, per se -- but is there a chance that you -- can you envision a 3M that can be a double-digit EPS grower, or is it really explicit in your model that you're going to be a lower risk but higher quality growth company?

I guess I'm trying to figure out how you think about EPS growth as it relates to top line.

If I could, Scott, this is David Meline.

I would say what you've asked is very much our thinking as aligned to what we talked about last year in November, which is we laid out a plan where we had 4% to 6% annual organic growth, 1.5 times IPI.

We think that that is certainly something that is reasonable for us to continue to expect to achieve.

You look at it, we said 9% to 11% EPS growth, which is a combination of both top line organic growth, as well as the earnings growth that we would expect to get from other activities of the business.

That would include acquired businesses, which we continue to believe are relevant to our model; that includes the impacts of also the non-operating items, such as the continuing reduction on share count.

We expect pensions to certainly contribute to our earnings going forward in the future years.

And we'll continue to balance.

We'll look at where the best opportunities are.

And to the point on this quarter, we think, certainly at the present time, where we can create the most value right now is to continue to invest towards the long-term health and growth in the business.

So as you point out, we are quite significantly investing in places like R&D innovation towards more disruptive technologies, improving our systems, which is a very important initiative for the company, and taking the opportunity to also, as we see areas where we need to maybe rebalance and restructure somewhat, which is part of the normal course of our business, we invest to improve our competitiveness there, as well.

Okay.

Thanks.

Congrats on the top line, guys.

Thank you.

Thank you.

Ajay Kejriwal, FBR.

Thank you.

Good morning.

Good morning, Ajay.

So the organic growth rate, clearly much better than expectations and much better than what we are seeing from other industrials in the quarter.

And that's great.

So maybe talk about how much of this performance is end demand.

I know you talked about share gains, market penetration, but maybe a little bit of color between end demand, share gains, and then how much restocking might have contributed to the performance.

Well, thank you, Ajay, for the question.

You know, when we look upon it -- I am assuming you are also talking a little bit of channel inventory and so forth.

First of all, overall the channel inventory levels appear to be balanced across businesses and geographical areas.

But we have to be watchful relative to the consumer electronic markets, particularly in the mobile and hand-held smartphone segment.

So I think that we had a good lift for that business, based on spec'ing on platforms and building for the holiday seasons.

So I think you saw a little bit of inventory build in order to be prepared for that.

Now all external facts that we see is saying that the holiday season for that segment will basically be flat.

So that's one of the reasons why we are very cautious as we go into the last quarter.

Now we had a very good -- you're right, we had a very good uptick here, specifically in the Industrial-based businesses.

And you have to assume that there is a slight improvement in the segments there.

But to be honest, we don't see any differences versus any of our competitors.

So what is happening here, the execution from our team relative to competitive conversion is working very well.

So overall, I will say that the channel inventory levels appear to be balanced, only for us to be watchful, which is based on external data relative to the consumer electronics market.

That's very helpful.

And you're getting really nice pricing, especially in the context that some Industrials are reporting pressure, and I guess that reflects the pricing power of your brands.

My question is, how should we think about pricing for you in a benign inflationary environment next several quarters?

Yes.

In terms of pricing, Ajay, certainly, if you look at the performance in Q3, we were pretty pleased.

We saw price performance was good pretty broadly across the portfolio, with perhaps the exception in the Electronics business, where you, of course, have structural price declines.

What I would say in terms of what we see, of course, geographically, we do have -- most significant price actions are going on in locations where you've either got weakening currency and/or inflationary pressures as a result.

So if you think about Latin America, again, we saw significant price movements.

We've also been working in Japan, where they've had, obviously, a significant devaluation of their currency, as well.

And then of course, right now our comps are a little bit easier in the second half, on a pricing basis, versus the second half of last year.

So at the end of the day, the issue for us is to continue to offer good, refreshed products which give us strength in the market to be able to command price that reflects the value we're offering to the market.

As we do that, that tends to provide also a very nice halo effect for the entire portfolio.

Thank you.

Very helpful.

Nice quarter.

Thanks, Ajay.

Thank you.

Steven Winoker, Sanford Bernstein.

Thanks and good morning.

Good morning.

Could you maybe just, again, go a little bit more through the cash flow and the fact that that recovers towards the end of the year, but still you're going to end up a little bit lower than you expect.

To what extent is that still driven by the additional growth?

Sure, Steve.

So if you look at cash flow, certainly year-to-date, we are running about the same level as we did last year, which is I guess, 76% year-to-date versus 75% last year.

Obviously, it bounces around some quarter-by-quarter.

And typically, for example, in Q4 we would expect better conversion, which is why we're expecting 90% for the year.

And what I would say is very much the 90% would be reflective of the fact that we are investing in the business, and at some level, as you get an inflection in demand as we're seeing, that tends to put some pressure on the working capital cycle.

So nothing unusual, but just a reflection of seasonality, really.

And more inventory and receivables based, or (multiple speakers)

Typically, inventory and receivables are impacted as you're ramping up towards a higher level of demand, yes.

Okay.

And then on the strategic investments and actions, you talked about the ERP implementation and such.

How do you see that progressing?

Are there any other -- when you think about those, are you qualifying also feet on the street additional, or what are some of the other actions that we can get a better sense of how that money is getting invested?

I think when we talked about the strategic investments here in this section, it was about investment in disruptive technologies that we talked about earlier.

It's about the ERP investment and then some restructuring on a couple of places around the world.

And if you think about our model, 3M's model is we are basically working on this the whole time.

I think one other thing here that we have stepped up is around the disruptive technologies, where we announced in November last year, on November 8, we announced that we had in the plan moving from 5.5% closer to 6%.

So that was a step up.

And the ERP is, of course, also something that we are investing in that will very much improve our efficiency and effectiveness and productivity as a company.

Restructuring is pieces that we do as we go.

We look into that and we finance that quarter by quarter, as you very well know.

That's part of the business model.

In terms of acceleration of growth -- and you talked about the feet on the street, in terms of commercialization -- we have, as I took office, now almost 24 months ago, we made a big effort in terms of marketing excellence and sales excellence and appointed individuals in order to lead that initiative type of more centralized in order to help with tools and so forth, but execute locally.

As we go, we make investment.

You saw here when David talk, in terms of investment, both in research and development and SG&A, we do that but in a careful way.

We also have to look upon different models in terms of commercialization, as we move ahead.

We have to adapt and make sure we do it in the right way.

But you have to look upon that every business group, by definition, are working towards their objectives in terms of margin expansion and growth, and that is where they ask for additional investment.

That is in addition to the three David and I talked about this morning.

Then that's layout and type of a normal business procedure as you grow your business.

But we feel good now.

We start to see the growth.

We have made investment, as you know, in Health Care, specifically.

We build out our capabilities in international some time ago, and we continue to see that delivering, which is very good for us.

We take market share.

We improve our penetration and we have good margins in that business.

The same with Consumer.

So we look upon it and balance it all together.

Those two businesses, Consumer and Health Care, are steady.

Continue to move forward.

And then we had the three other business groups really ticking up this quarter, including Safety & Graphics, as you saw, had a very good quarter for us.

Thanks, Inge.

Thanks, David.

Thank you.

Andrew Obin, Bank of America Merrill Lynch.

Yes.

Good morning.

Good morning, Andrew.

I just want to follow-up on what Scott was asking you.

As I think about the quarter, you're getting fantastic pricing.

The emerging markets, which is high margin is outgrowing.

Health Care margins are going up and is outgrowing.

You seem to be making very good progress on Energy & Electronics.

And your framework is top line growth of 4% to 6% and EPS growth of 9% to 11%.

But it seems in a quarter where everything has gone right, we still can't get over double-digit EPS growth.

And the question I'm asking, what would it take for you to get over double -- what set of circumstances would get you to get over double-digit EPS growth, if we can't get it in a quarter like this?

Yes.

So I would say, Andrew, certainly we think as we look at it quarter-by-quarter and year-by-year, we think it's very reasonable, from a planning perspective, to expect to deliver our 9% to 11% EPS growth on the kind of growth that we're laying out here.

And at the end of the day and one particular quarter or another, you'll have more or less impact of whatever it is, a medical device tax, the ERP spending, some restructuring acquisitions.

So I don't view this as something that causes me to think that we don't have the ability to deliver on our plan, quite honestly.

Okay.

So just a follow-up question.

You addressed the gross buyback.

But what is the change in net buybacks for the year?

We would expect at $4.5 billion to $5 billion that our net would be around $3 billion to $3.5 billion for the year.

And the previous was?

Sorry.

The previous would have been about $1.5 billion less than the gross, so that would've been, what, $2 billion to $3 billion.

So it's not options.

It's all going to net buybacks.

The increase that I'm talking about today would largely be reflected also in the net.

So the gross increase --

Okay.

Thank you very much.

Our outlook on the redemption side has not changed.

So the whole change would go to net.

Thank you.

Thank you very much.

Thank you, Andrew.

Deane Dray, Citi Research.

Thank you.

Good morning, everyone.

Good morning, Deane.

On the Industrial side, that was one of the few businesses that showed operating margin down year-over-year.

And you showed nice organic revenue growth in the quarter.

Was the margin hit mostly from Ceradyne, or were there any other items that would have created that pressure?

Sure, Deane.

So just to frame the performance in Industrial.

First of all, we were quite pleased with the way the growth inflected up for us to 6% in the quarter.

And if you look at that, first of all, it was a combination.

It was both developing markets, which grew 7%, and we saw quite a strong improvement in our developed markets, where we grew 6% in Industrial.

So point number one.

Point number two is, if you look at last year, we were at a 23% margin.

So it was certainly an exceptional quarter we were comparing to last year.

If you look at our core operating margin in the quarter, we were a little over 22% excluding Ceradyne.

And the other impacts that brought us from that 22% down to the reported 21% were basically the same ones we talked about elsewhere.

So the impact on Industrials margins of the disruptive R&D technology investments, because those get spread through the businesses, the impact on their business of the ERP investment, which is about 30 basis points, FX impacted them negatively.

And then one thing we haven't talked about today, but it's impacting across the enterprise this quarter, is we've ramped up now, we're in the process of putting in place -- well, Inge mentioned it -- our new European supply chain activity.

And so that's having some impact on us here in the third quarter, as we ramp that up and get ready to go ahead and go live.

Great.

And then, Inge, I was real interested in hearing that this promise that you made a while ago when you closed on Ceradyne, you were very excited about how many different divisions across 3M leverage ceramics, and here we are seeing, I think you said, nine divisions will be launching products --

Correct.

-- that leverage Ceradyne in some way.

So just give us a sense of where are those products?

Will those be 2014 events?

Are there more to come?

Because there are certainly more divisions that leverage ceramics at 3M and potentially for that technology.

But just provide us more color (multiple speakers)

Well, I think, from a business group perspective, you will see it mostly in the Industrial space, but you will also see it in some businesses in Health Care, in the Orthodontic piece.

We say now that there's nine that are ready to commercialize.

If you recall on our call last time, I talked about 13 to 15 divisions that are looking into it.

And they are continuing to looking, and it's actually expanding.

So the answer to your question, more to come, yes, more to come.

In terms of the nine that we quote here today, they will roll out different type of activities during 2014.

So when we look upon that acquisition in total, we are very pleased, first of all, the integration is fully completed now.

So we are pleased to report that, fully integrated to 3M.

And as you have seen now, we have taken a couple of sizable orders.

We announced last quarter an order around $40 million.

And as David talked, we got another one this quarter of $80 million that will start to be delivered next year.

We will not deliver that this year.

So we got the order.

We are now qualifying it.

And it will roll out next year.

On the bottom line, as David said, we are meeting and exceeding our blue book and bottom line.

So in terms of both get something in the front end, around $400 million.

And then get technology in the back office that we can leverage is a fantastic thing for us.

Yes, just to put an exclamation point on that.

I know there have been a lot of skeptics at the time of Ceradyne's closing that some of the military orders were in jeopardy.

And since then, that looks as though that was not the case and that $80 million order here came through.

Are there others like that?

Well, you can say it's actually $120 million, because we had $40 million last quarter, $80 million this quarter.

So that's $120 million.

And that is one of the segments for that business.

So I cannot comment on orders that we are negotiating that is not finalized, but we are very encouraged with what we see.

Thank you.

Thank you.

Laurence Alexander, Jefferies.

Good morning.

Could you give a little bit more detail on two end markets?

With the electronics growth you're seeing, can you parse how much of what you're seeing is because of your own pivots or share gains as opposed to the health of the underlying market?

And then in the Safety & Graphics Architectural Coatings, can you talk a little bit about sequential trends that you're seeing there?

Well first of all on Electronics & Energy.

The Electronics piece grew 4% for us, and the Energy piece grew 3%.

And in the Energy segment, it's to the ACCR that David talked about.

That's clearly we're taking market share.

So we are now taking quite a number of orders, and very much back in West Europe, which is encouraging for us.

As you probably recall when we talked earlier, that's a relatively long -- I would say not relatively long, it's a long sales cycle for that product.

And that's now start to be qualified, spec'ed in, et cetera.

So we see orders coming in many countries in West Europe, specifically, as they are interacting us.

So I think in that piece, you can clearly say that we are taking market share in the Energy piece of the segment.

On Electronics, I would say for us, we will be spec'ed in on platforms, and we are.

And that's one of the uptick we see.

And then I would say, generally speaking in that segment, we have a strong position.

We have always had a strong position, and what is working well for us is that we are both able to provide technologies that will enhance those products for our customers and able to drive down cost as fast as possible.

In terms of real market share data there, I think that will be more a result of how the sales, too, will come in the end of the day, because as I said, we take it very easy now as we go into Q4 and make sure that we sell through in the channels.

On Safety & Graphics, what was your question there, relative to --?

Just the weakness you cited on Architectural Construction markets.

If you could maybe talk a little bit about what you're seeing sequentially?

And then again, if you can parse your own performance to the degree you think you might be losing share, or if you think you're gaining share relative to the market?

First of all, that is a relatively small business for us.

We started that a couple of years ago.

The base for that business was actually Japan, from the beginning.

Japan have done very well building out that business.

And we took the Japanese model and adjusted it and tried to build it out, first and foremost in United States, and also in some selected places in West Europe, with Italy being the center of it, relative to design.

So I would say that when I look upon that, it's not losing market share.

I think it's temporarily a shift in the marketplace and so forth.

It's not a concern, generally speaking, that business for us, in terms of if we are losing market share.

More project-based so it tends to (multiple speakers)

Yes, it's a project-based business.

We see a little bit of that going in and out of quarters.

But we are doing very well there with some of our films that is coming out from our film technology laboratories.

And we are doing very well in lighting, generally speaking.

So look upon it more as project-based, can go up and down a little bit.

The business is relatively small for us.

Thank you.

Thank you.

Shannon O'Callaghan, Nomura.

Good morning, guys.

Good morning, Shannon.

Inge, could you maybe just give a little more flavor on these 20 new product platforms you're funding in terms of these disruptive technologies, general areas you're talking about and maybe the rough size of the opportunity you see?

Yes, I can.

I will not talk about all 20, but I can talk just to give you a flavor of what we are doing there.

So just to go back to the background.

This is based on that we step up the investment in research and development from historically 5.2% to 5.5%, closer to 6%.

And that those manage to go into the, what we call, classify, more disruptive technologies.

And there's a couple of products -- and I would just talk about them that is maybe closer for us, because there is a couple of them that are in the first stage, very close to the first stage development of completion, and that will be rolled out in 2014, maybe in the middle of the year to later in the year.

But we are encouraged around them.

And there's a couple of them.

Barrier film for building constructions is one that is based on something where we believe we should be able to capitalize on some growth relatively fast.

There is a protective film for electronics and appliances which is very encouraging, that can be used for OEMs that are into appliance and electronics.

There is light management constructions that are both into residential and commercial.

So if you think about those three are all coming out from our film technology platforms.

There are smart grid sensor cables that we believe will be something we should be able to commercialize fast and effectively, and West Europe is a target for that, specifically.

And then we have the quantum dot enhancement field that is just on the way to be rolled out.

So if you look upon it, you can see it's much here around our base in technologies from platform perspective.

It's going into businesses that are everything from Electronic & Energy to the Safety & Graphics and Industrial businesses.

So you will hear more about them as we go, but they start to be real.

And at least for me and for us to see -- as you saw, it's type of five platforms that start to come to life and that we believe that we should be able to roll out during 2014 is very encouraging.

So we are very pleased the way the organization took this initiative to heart, moved it forward, and we are focused a lot and make sure we give the bigger program more resources and type of some of them that was good initial piece that may be dreams that you always should have, we maybe reprioritize them.

Okay.

Thanks.

And David, if I could take one more crack at this EPS thing.

Putting the quarter-to-quarter variability and things aside, the high end of the organic range now for this year is 4%, which should probably, in your framework at least, flip to 9% EPS growth.

And it's not this year in the guidance.

So is there -- you're getting a little hit from FX.

Is that it?

Or is there anything else this year that's not converting -- making the 4% equal 9% that would in the broader framework?

Sure.

So if you look at over a long period of time, acquisitions, we have certainly top line contribution.

We're not seeing significant, at the moment, bottom line this year.

Pension, we had a contribution this year.

We had about $100 million, so that's contributing.

Tax, I think, is pretty much carry over year-over-year, and that's a contributor, if you recall, in our five-year bridge.

We've got a couple points of tax, so that would be something that's not present in the current calendar year.

And then the last one would be, frankly, we are investing quite heavily in the front end, for example, with this R&D innovation initiative, which should contribute in the future.

So it's kind of pay now in terms of long-term investment with future results.

Same is true with the ERP system.

So 2013 is sort of a heavier loaded investment year.

Would that be the main difference?

Yes.

Correct.

Okay.

Thanks.

Joe Ritchie, Goldman Sachs.

Hi.

Good morning, everyone.

Good morning, Joe.

Just following up there on Shannon's question, moving from 2013 to 2014, it seems like you have had a lot more of a heavier year this year, both on ERP spending, the R&D spending.

Talk us through maybe some offsets into next year.

Or is it possible, if we do get an acceleration and start to see 5% to 6% growth, that the incremental margins on the business will get a lot better, and so there will be better pull through in 2014 versus 2013?

Sure.

So if you look at 2014 -- obviously we'll come out with that here in December -- but if I frame how we're thinking about 2014, I would start, which is we certainly are constructive on the overall macro economy.

We think we will see some improvement in both industrial production and GDP.

Although we think the improvement's going to be slow, but directionally we are encouraged.

We will continue to invest in 2014.

So the investment, if you look at, we talked about going to 6% on R&D.

We are on that path.

And incrementally, we'll invest more next year in R&D.

Same with ERP.

That will be likely our peak year of investment in the ERP system, and so that will be part of the plan next year.

We do expect, in terms of the things that are in view, we do expect pensions now to be, certainly $100 million or more of expense benefit next year.

And then finally, based on what we've been doing with the reducing the share count through the year, you can expect that will be additive to EPS again next year, as well.

So I would say we feel quite good about the momentum that we have right now going into 2014.

And we'll be able to share more detail here in December.

That's a helpful bridge, David.

Just clarification on the incremental spending on ERP.

I think I had it at roughly $50 million incremental next year.

Am I ballpark, or (multiple speakers)

Yes.

That's still in the right ballpark.

Okay.

Great.

And then one last question on growth for 4Q.

Implicit in your 4Q guidance, I'm just curious, from a year-on-year perspective, you had really nice growth organically this quarter at 5.8%.

Does your guidance essentially imply that there will be a step down sequentially on a year-on-year growth perspective, just given some of the commentary that you've had on the Electronics business?

Yes.

Well, if you look upon the 3% to 4% for the year, that implies roughly 2% to 6% in the last quarter, which is in line what we have done for the year.

So I think the way we look upon it, we are very focused now to make sure we end the year strong here.

And I think the business that we're just cautious, as you call out yourself is -- and what I've talked about -- is the Electronic & Energy, as we move ahead.

But talking about that business, you think about it, generally speaking for us, you think about the margins for that.

We have gone now through the capital quarters.

We went 15.3% in Q1 to 17.7% in Q2, and 20.7% in Q3.

So constant improvement on the margins.

And we have said from the beginning of the year that we will deliver high teens for the year for that business.

And that's what we believe we will do.

So I think that Q4 will be a little bit more of a challenge for that business, but very pleased with the progress, both in terms of growth and the way they have been driving productivity in the underlying operation and taking their portfolio management to heart and really improving that business.

Okay.

Thanks, Inge.

Thanks, David.

Thank you.

Steve Tusa, JPMorgan.

Hello.

Good morning.

Thanks for fitting me in.

Good morning, Steve.

On the Health Care gain that you guys had, in total company bridge, where is that discounted?

Is that under organic volume or the Med Device Tax Other line?

That would be in Med Device Other.

Okay.

That's within there.

And then on Ceradyne, it was a little bit more of a headwind to margin.

It looks like it was kind of break even this quarter, relative to -- I think it was mid single-digit margins last quarter.

Is that seasonality or further acquisition charges or investment?

What's going on there?

It's a combination, Steve.

One, the booking of orders tends not to be -- there's some lumpiness in terms of those projects.

So we had a pop-up in Q2 which was a little bit less in Q3 now.

And then secondly, there's been quite some integration activity which has impacted expenses here in the quarter, so that also is part of what contributed there.

Okay.

And then just one last question for the year, the margin.

You guys have given sales guidance, to baseline people on the fourth quarter.

What's a good range for the total operating margin for the fourth quarter, or just for the full year?

For the full year, we --

For the total company.

We expect it to be pretty similar to what the full year was last year.

Okay.

Great.

Thanks a lot.

Thank you.

Nigel Coe, Morgan Stanley.

Good morning, and thanks for going long here.

Good morning, Nigel.

So Inge, you talked about the pickup in investments for some of the classified initiatives.

Yet R&D has been pretty flat year-to-date, about 5.4%.

So I'm wondering if you're getting better base productivity within R&D, and do you still see 6% as the true long-term target?

The 6%?

Yes.

Well, first of all is, it's clear for me that we start to see more productivity out of the laboratories.

And I'm pleased to see that, to get both investment in R&D and productivity on the same shot is fantastic, when you do that at 3M.

And we start to see that.

And we are just ending up our strategic planning cycles here.

And I can tell you, when I looked upon every business group, when I looked upon International and I look on the total company line out and investment and productivity target for research and development, I was very pleased.

So more effort on that.

So the answer to your first question is, yes.

Is 6% right, as we go?

I'm not changing that, at this point in time.

I think it's important, we're staying the course relative to make investment relative to research and development, because I believe, and we believe, and it's the DNA of the Company.

That is the heartbeat of 3M.

That is where we really make a difference as we move ahead.

But again, we are very focused on making sure we get productivity out from every programs that we put in place.

But we are not changing the target for the plan.

Productivity is improving, and so overall we feel good about it.

Okay.

That's helpful.

And then switching to David.

Obviously, the free cash conversion has been depressed by CapEx running well ahead of tangible D&A.

And I'm just wondering, given the ambition to raise CapEx to $2.1 billion over the five-year plan, when do we start to see tangible depreciation stepping up?

And we've had a lot of questions about the 10%-plus EPS growth.

And I'm just wondering to what extent that step up in tangible is a headwind to EPS growth over the next five years?

In tangible?

You're saying a step up in depreciation?

Is that the point?

Yes, as depreciation catches up with CapEx.

We don't see -- I don't foresee a significant step up in depreciation, if you measure it as a percent of revenue.

So we expect to be pretty steady in terms of CapEx percent of revenue.

If you assume the profile of the CapEx is not dissimilar to the past, that would imply that depreciation would track with revenue growth.

So I don't have that pegged as a headwind in the business.

And if anything, we're expecting with the completion of both the globalization of our capacity and secondly, as we get in place this ERP system and get better visibility on data, we think we'll have a chance to run our supply chains more efficient.

Okay.

Thanks a lot.

Thank you.

And our last question is a follow-up question from the line of Andrew Obin of Bank of America Merrill Lynch.

Please proceed.

My questions have been answered.

Thank you.

Thanks, Andrew.

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

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

Well, thank you very much for joining us today.

Thanks for your time.

Appreciate your questions very much.

Very much appreciate your interest in 3M, and we look forward to speaking to you soon.

Thank you.

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.