3M Company (MMM) Q3 2007 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the 3M Third Quarter 2007 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in the question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded Friday, October 19, 2007. We would now like to the turn call over to 3M.

Good morning this is Matt Ginter, Head of Investor Relations for 3M. Welcome all investors and analysts to our third quarter business review. And let me also say, it was good to see many of you are at our meeting in St. Paul last week. I have a few announcements before we begin today's meeting. As in prior quarters, we will be doing a PowerPoint presentation today. The slides are posted on our website at the moment, at 3m.com, so can you pull them up there. These slides will remain on our website, along with an audio replay of today's call for an extended period of time. During the call today, we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results. And 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 Forms 10-K and 10-Q lists some of the most important risk factors that could cause actual results to differ from our predictions. On our call today, we have George Buckley, our CEO and Pat Campbell, our CFO. Both will make some formal comments and would get to your questions. There are a number of other companies reporting today and we all know how busy you are during the earnings season. So we will keep the call today to one hour. We will try to be... move swiftly. We will answer as many questions as we can. If you could please limit to one question and one follow-up, we will do that and if you have a follow-up question beyond that, get back in the queue and we will do everything in our power to get to you. If not, we will be around all day to answer any follow-up questions, that is, Bruce and I. So you please now go to slide number three and I would like top turn the program over to George.

Thank you very much Matt. Good morning everybody. First of all, I want to thank many of you were able to join us at our meeting in St. Paul, last week. I very much appreciate your participation and your interest in this great company. I know that the time and commitment you gave to us was significant and we are very grateful for that. From my point of view, we had two very productive days and I hope that you'll now have a better idea of why we are so optimistic about 3M's long-term future. We'll obviously avoid repeating here what we told you just a few days ago. From your point of view, I hope that we help remove some of the mystery about our company and provided some insight into our approach to operational excellence and discipline, into our commitment to invest in technology and innovation and new products, and how the underlying strength of our broad and diverse portfolio carries us forward. The access that we provided also to our scientists and to our engineers, to our manufacturing people, to our various product specialists and to management also, should have been very helpful. So let's now turn to the third quarter. This was clearly another good quarter for 3M. Obviously not everything went perfectly and it never does, but given some tough end-markets in the U.S., many things did. The strength of our portfolio was evident again in the third quarter results. All of our businesses posted positive worldwide local currency sales growth on our way to a record third quarter sales of $6.2 billion. Other preferred [ph] growth a little bit above 9.4%, absence sales lost in divestitures, which we saw in the third quarter, but we clearly move in the right direction. It was, overall, a strong quarter and especially strong in healthcare, which grew 20.6%. Europe and Latin America also exhibited similar strength, with both regions posting double-digit sales growth. I am also pleased with our EPS growth of more than 10%, especially in the context of the extra investments that we've been making in R&D supply chain and in advancing our brands. We have shown that, we are indeed able to maintain premium margins while accelerating our investments, giving us additional confidence that our longer-term plan is on-track. To say on track is important, as we continue those investments in growth, especially internationally. If these numbers... in these numbers we absorbed a total of $35 million of commodity inflation in the quarter. So, as we reminded you last week, we continue to work our long-term growth plan, while getting the job done in the short term also. We know well enough that eggs today are sometimes better than chickens tomorrow, but having said that, investment in R&D is tracking to end the year at an increase of 10% more than it was last year. We are also working hard to drive international growth through brand building and making use of local and regional brands where they make sense. This also seems to be working well. Our supply chain is being strengthened and streamlined. We are investing 35% more in CapEx than last year and so far have brought on-stream this year five new plants outside the United States. We also announced two further acquisitions in the month of September, this makes 15 acquisitions year-to-date and I wouldn't be surprised if we announced a few more before the year is out. So all in all, a strong third quarter; we continue to work our plan and we are as confident as ever in our long-term future. In our investor meeting, we highlighted that 3M's success over the long-term is defined by our ability to apply ongoing innovation to build what we call Engineering Franchises. Franchise like Scotch tape, Post-it notes, Trizact brand abrasives and Scotch-Brite brand reflective sheeting. We also explained that we are looking hard to extend that concept of an Engineering Franchise into our optical-film business. Similar to the other examples, we invented the basic technology. As the market changed, we historically moved to serve all market segments from the bottom to the top of the market. So, today we are also doing that same thing in optical. We don't still foresee any technological substitution of LCD TVs in particular, in high volume to many years to come, so this is a great long-term market. But it is essential that we better serve all the segments included the faster-growing but more turbulent lower levels, where for a while, we can expect further pricing and margin pressure over time. For now this is the area of highest growth as customers seek out to receive higher value. I want to reinforce what I told you last week, it's our firm intention to protect and build that optical franchise, in order to extend and strengthen our position over the long term. To apply our technology, our market knowledge and our manufacturing prowess in the same way that we build the engineering platforms, I had mentioned earlier. So, thanks for your attention, I'll now turn the call over to Pat for more in-depth discussions of our results.

Thank you George and good morning everyone. As George indicated this quarter, we demonstrated the strength of our portfolio from both a business and geographic perspective. For the second consecutive quarter, we had sales greater than $6 billion. We maintained strong operational discipline while at the same time continue to invest in the business to drive long-term sustainable shareholder value, all consistent with the themes we talked about in last week's investor meeting. As explained in our press release this morning and shown on slide number five, third quarter reported earnings per share were $1.32. Included in this result are two special items, which I would like to explain in some detail for you. First, we made the strategic decision to consolidate our global Flexible Circuits manufacturing operations from two plants, one in Columbia, Missouri, the other in Singapore, and to our Singapore plant, to better serve our customers who are primarily in Asia. Second, as I mentioned during our investor meeting last week, we expect to have a handful of real estate sales over the next several quarters, as we actively manage our real-estate portfolio. During the third quarter, we sold our current lab facility located in Swan, Korea, which happen to be located on a very valuable piece of property. And we are currently building a new state-of-the-art customer-oriented R&D facility closer to Seoul, and many of our major [ph] customers for only 40% of what we sold the property for. After addressing for these two items, the earnings for the third quarter were $1.29 per share. Please refer to today's press release for more detailed discussion for these special items. As we discussed in last quarter's earnings call, generally accepted accounting principles prevent us from classifying the divested pharmaceutical business as a discontinued operation. Therefore it raised a year-on-year comparability issue. Q3 2006 revenues for the Pharmaceutical business were $201 million and operating income excluding special items were $73 million or $0.07 per share. Adjusting for Pharma and special items, earnings per share increased 17.3% year-on-year. On slide number six, we compare our third quarter P&L versus last year's third quarter. As you can see on this slide, our results this quarter are very much in line with our overall goals of accelerating top line growth, maintaining our strong operating margin position, while at the same time investing in growth for the future to drive long-term shareholder value. Excluding special items, earnings per share were $1.29, a year-on-year increase of 10.3% on sales growth of 5.5%. Adjusting for divestures, mainly Pharma, earnings increased17.3% on sales growth of 9.4%. Operating income was up 3.3% to $1.4 billion, or up 9.3% excluding divestures. Gross margin and operating income margin were 47.8% and 22.6% respectively, were in line with last year's third quarter after adjusting for the impact of divestures. R&D and related expenditures were up 10% year-over-year excluding divestures to support our overall strategy to reinvigorate our business core. SG&A expense was up 3.8% year-on-year at $1.2 billion, or up over 9% adjusted for divestures, as we stepped up investments in sales and marketing including an increase in advertising and merchandizing, to drive growth in many of our businesses. Our third quarter tax rate was 30.8% and down 1.9 percentage points versus last year. The lower tax rate in the quarter was principally due to a one-time cumulative impact of tax rate changes for several of our European subsidiaries. We now expect our full year tax rate to be in the range of 32% to 32.5%, as a result of this quarter's lower tax rate. Please turn to slide seven for a recap of our third quarter top-line performance. Worldwide sales in local currency increased 6.3%, with 8% from our international operations and 3.6% from the U.S. Organic volume worldwide was 4.2%, led by 7.1% increase in international. Internationally, Europe turned into another very strong quarter led by safety, security and protection, healthcare and consumer-office business with local currency growth of 11.8%, 8.1% of that was organic. Rounding out international, Latin America and Canada and Asia-Pacific regions saw a local currency growth at 11% and 4.1% respectively. Organic volume growth in the U.S. was up slightly, as strong growth in healthcare and electrical communications was offset by weaknesses in a handful of businesses that are impacted by the slowdown in the U.S. housing, low construction and niche retail markets, mainly our industrial minerals, protective materials, traffic-safety and office-supply businesses. Worldwide, acquisitions contribute 2.1% while prices were flat versus last year's third quarter. Divestitures, primarily Pharma, decreased sales by 3.9% and currency translation added 3.1%. Before we move to the business segment highlights, please refer to slide eight. We would like to comment on our year-to-date performance. Excluding divestitures, mainly Pharma, sales were up 10.4% year-to-date with operating income up 12.5% and earnings per share up over 17%. Capital efficiency is equally important to growth and margins. Our return on capital was 22.2%, up 40 basis points from last year's comparable period adjusted for divestitures, mainly Pharma. As you can see, through nine months, we continue to execute as per plan of accelerating growth, maintaining margins and investment returns, while delivering double-digit earnings growth. Overall our plan continues to remain on-track. Now please turn to slide nine, where I will review our quarterly and year-to-date results by business segment starting with industrial and transportation. Driven by broad-based growth across the portfolio, our industrial and transportation business delivered another great quarter, with sales growth of 9.3% and operating income growth of 11.4%. Sales growth was led by our industrial adhesives and tapes business, followed by automotive OEM, automotive body shop solutions and abrasives businesses. Organic local currency sales increased 4.2% with an additional 1.2% of growth coming from acquisitions. Year-to-date, sales were up 8.2% with operating income growth of 10.7%, as our business continues to drive strong productivity programs with operating margins up 50 basis points year-on-year to 21.3%, a record margin for this business. Some of the products driving growth in the third quarter were specialty chemicals for the oil and gas markets; paint preparation systems that deliver productivity and paint booster body shops; Laminating adhesives providing attachment solutions in industrial applications; and packaging tapes, just to name a few. Strong market penetration in the emerging markets, particularly the BRICP countries continued in the third quarter. Europe, Middle East, Africa as well as Latin American regions all showed strong local currency growth. Industrial transportation business continues to invest in R&D, to strengthen its core technologies or adding strategic complementary acquisitions to boost our core adhesives, tapes and the abrasives platforms and to expand into the adjacent markets. We recently announced the acquisition of Venture Tape Corporation, a global provider of pressure-sensitive adhesive tapes based in Rockland [ph], Massachusetts. Venture Tape manufactures a broad range of tapes using construction, oil and gas, HVAC, electronics, aerospace, marine and appliance markets. This acquisition broadens our pressure-sensitive adhesive tape platform, bringing new channels to 3M and allows us to expand into adjacent markets such as the global construction market. Please turn to slide 10 for a review of third quarter results for Display & Graphics segment. For the third quarter, Display & Graphics sales were up 2% or over $1 billion, a record quarter. Sales growth was negatively impacted by over 2%, due to the divesture of the Opticom and Canoga loop business along with product rationalization in a couple of our other businesses. Local currency growth is 1%. Year-to-date Display & Graphics sales have increased more than 4% with profits up nearly 6%. Our market-leading optical systems business continues to focus on market segmentation with strong penetration in handhelds, computer displays and LCD televisions. We did experience attachment rate loss in LCD desktop monitors and LCD TV segments in Q3, as competition continues to intensify in this market. We also noted a slowing in the mix from 720P to 1080P LCD TVs, which impacts our business as 3M films are used more heavily in 1080P sets. As the market leader, we will continue to compete aggressively, dousing product innovations, price and volumes across the entire brightness-enhancement film product pyramid. This means continued price down to meet our customers cost down requirements. Our continued commitment to invest in this business has led to a solid stream of new products that our customers are very excited about that will allow us to continue to maintain our market leadership in brightness-enhancement films. 3M's brightness-enhancement films provide an environment solution to reduce energy consumption, a rapidly increasing requirement from retail customers and government units. We're also on our schedule in scaling up and improving the productivity of our manufacturing facilities. Commercial Graphics posted another solid quarter with strong sales growth. We saw an uplift in the vehicle-wrapping market where we provide films, inks and other products for this rolling billboard industry. Likewise, in traffic safety systems, we have posted continuous seasonal growth internationally, driven largely by the road construction season. The U.S. highway construction market work slowed in third quarter sequentially from the first half of the year, as the industry is facing substantial material inflation for cement and asphalt, which is driving more of the spend in the construction materials for road servicing versus other spend such as sign sheeting. Please turn to slide 11, where we will discuss the third quarter highlights for our healthcare business. Once again, healthcare had a great quarter with broad-based double-digit growth across all divisions, excluding Pharma. Local currency growth, including acquisitions was 16.6%, with 4.6% coming from acquisitions. Of the remaining organic growth, 4.5% resulted from our recent supply agreements related to the sale of our branded Pharmaceutical business, in which our drug delivery systems business became a supplier to the acquiring companies. Of the 4.6% of growth from acquisitions, much of it came from two deals. Biotrace International, PLC, a U.K.-based provider of microbiology products and SoftMed, a Maryland-based provider of health information software solutions. We also acquired Neoplast, a Bangkok-based manufacturer and distributor of consumer and professional skin and room care products. Excluding Pharma, sales in healthcare were up 20.6% over the third quarter of 2006 and profits were up 13.7%, ex-Pharma to $259 million. Year-to-date margins were 27.7%, overall sales were up 22.7% year-to-date and operating income was up 19.1%, both excluding the sale of Pharma. Within the segment, each business delivered double-digit sales growth. Our drug delivery systems business where we leveraged multiple 3M technologies, global regulatory expertise and manufacturing precision led the way. We also saw strong sales in health information systems, where we are the worldwide expert in healthcare funding and performance management solutions. In dentistry, we continued to deliver a steady stream of new products and have been voted the most innovative dental company, two years in running. In fact, we just recently launched a new product in dental, which is new to the world technology that creates a lower shrinking composite filling material available along our two state-of-the-art adhesives for better bonding and patient comfort. In orthodontics, where Self-Ligating Brackets are the fastest growing segment in the market, 3M's exclusive SmartClip braces system is leading the way and we saw impressive double-digit growth in that business again this quarter. Please turn to Slide 12 for details on our consumer and office business. Consumer and office sales increased 5.9% to $898 million in the third quarter. Local currency sales were up 3.5%, including 1.1% from acquisitions, primarily due to the October 2006 acquisition of Nylonge, a global provider of household cleaning products including cellulose sponges. Profits were $192 million, with operating income margins of 21.3%. The consumer and office business is having outstanding year, with year-to-date sales, up almost 8% and operating profits up 12%. Year-to-date growth is being lead by the consumer mass retail and the do-it-yourself retail of channels; strong growth in homecare and from Scotch-Brite scrubbing products. In construction home improvement, growth came from Filtrete, air filtration for the U.S. residential HVAC systems along with command mounting and fastening products in the third quarter. As previously mentioned, sales growth was tampered by a weakness in the protective materials in the office mass retail channel in the U.S. Geographically 3M's international subsides contributed to drive growth again this quarter, with double-digit growth in all regions led by Europe. During the quarter, we stepped up investment in advertising and merchandising to drive growth from the back-to-school season. We'll continue to invest in advertising during the fourth quarter to accelerate growth during the holiday season. Please turn to slide 13, for a recap of our third quarter performance of our safety, security and protection services. Led by growth in respiratory protection, growth in protection and building and commercial services, we delivered sales growth of nearly 11%. Third quarter growth in local currency was 6.7%. Overall segment year-on-year sales growth was held back by almost 2%, due to our industrial minerals business which supplies mineral used on asphalt shingles for the U.S. residential housing market. As you are aware, housing in the U.S. remains very sluggish and our industrial minerals business is really a U.S-centric business. Geographically, sales growth was led by strong double-digit growth in Europe, followed by Latin America and Asia-Pacific. For those of you that attended our investor meeting last week got the opportunity to see the products and technologies of Rockford Thomson Equipment Ltd, a recent acquisition by our security business. Rockford Thomson is a manufacturer of optical character-recognition password readers used by airlines and immigration authorities headquartered in Newbury, U.K. The addition of Rockford Thomson enhances 3M secure document-scanning solutions portfolio and allows expansion in the transportation markets, such as international airlines. Operating income increased almost 11%, as the business continue to maintain consistent operating margins in excess of 20%. Year-to date sales have increased 16.6% with profits up 15.7%. Please turn to slide 14 to review the third quarter results for our final segment, Electrical Communications. The growth results in this business continue to be mixed. However, the financial results continue at record levels. We continue to experience strong growth in electrical markets and communications markets, which have been somewhat offset by declining growth in some of the products we supply in the consumer electronics market, which our end devices that have come to end of life, adversely impacting sales in our Electronic Solutions division. Electronics Markets Materials division started to see some recovery in the third quarter in consumer electronic applications, fueled by demand for fluids. Overall the electrical communications business has taken the necessary corrective actions to respond at the slowing consumer electronics market. As mentioned earlier, the Electronics Solutions division announced a consolidation manufacturing operations and reductions in structure, to allow the businesses strengthen their competitive position. At the same time, our electrical markets and communications businesses delivered a strong double-digit bottom line growth, offsetting the weakness we saw in the consumer electronics piece. Sales were up 7.6%, over the third quarter last year with local currency growth of 4.3%, including 110 basis points of growth from the acquisitions. Strong results continue in Europe and in the U.S. for communication and electrical markets. Outstanding cost discipline continues to generate profits that increased 16.4% over the same period last year, with margins up 1.5 percentage points to 19.6%. Year-to-date sales reflect a strong first half, with an increase of 4.9% and profits increased 13.5%, versus the first nine months of 2006. Please turn to slide 15, where I will review a few balance sheet and cash flow metrics. Excluding tax payments related to the gain and sale for the branded pharmaceutical business, free cash flow in the quarter was $693 million. This year-over-year cash flow drop is more than accounted for by higher tax payments. Third quarter free cash low includes a $200 million U.S. pension contribution, which is the primary driver for lower free cash flow from Q2. Both year-on-year and sequential working capital turns have stabilized at five turns. Capital expenditures totaled $379 million, an increase of $67 million year-on-year and $31 million sequentially. Year-to-date, we have invested greater than $1 billion in capital expenditures, on-track with our full year expectations of $1.4 billion to $1.5 billion. Dividend payments to our share holders were $343 million and we continue to buyback stock during the quarter, albeit at a slower pace than previous quarters, with gross share repurchases of $557 million. Weighted average diluted shares outstanding of 729.9 were down 3.5% year-on-year and down slightly sequentially. And finally, our debt-to-cap ratio was 32.3% at the end of the third quarter. This concludes my formal business review. Now, I would like to turn the call back over to George for his closing comments. George?

Thank you very much, Pat. So let's speak now about the rest of the year. To set the scene, the third quarter was characterized by some ups and downs, as there always are. For example, we saw good results in oil and gas, mineral extraction and aerospace. We also saw surprisingly strong results in industrial tapes and adhesives, abrasives and most of our global automotive business. We also saw some late quarter rejuvenation in our electronics business as Pat mentioned. Particularly those selling bonding sealing materials into the electronics industry, as it finally seems to come out of the deep sleep that we've seen most of the year. Our construction and home improvement business also did very well posting 7.5% sales growth as we continue to bring share and launch new products. Our investments in R&D and in acquisitions are clearly paying dividends in all of these areas. On the other side of the equation, it will be no surprise to anyone that we saw continuous softness in the roofing granules business, which continues to drift down slowly in sales. We did not expect to see sales growth improvement in this business anytime soon, even though it's performing relatively well from an earnings standpoint. The growth in optical films for LCD TVs is currently slower at the top of the market where our position is strongest. Consumers are driving the lower reaches of the market fastest right now. And as we mentioned in our investor meeting, we have new products coming in Q4 and Q1 to broaden our offerings, as we invest in advance our leadership position in that market. As a practical matter defending our position here will cost us some price in Q4. But the long-term effect will be to extend our optical franchise which remains a very good business of 3M today and well into the future. While consumer markets did moderately well in the quarter with overall growth of 5.9%, we do see signs that replenishment orders mostly for use in offices are slowing, this is all a U.S-based phenomenon and international markets remained robust as Pat outlined. So for the balance of the year, we expect to see the pattern of absolute growth remaining at level similar to what we've seen in Q3. The business environment in the U.S. market remains the biggest immediate challenge as we go forward. However, we remain committed to our 2X IPI goal and while the rest of our portfolio helped us enormously, I think we all know that it can't fully insulate us from economic effects. However, whatever economic scenario we might encounter in the U.S. going forward, we retain the resolve and the means to fight hard to market share, continued growth and profitability. That's what we will be doing. So with respect to earnings, we expect to finish the full year between $5.54 and $5.62, up from last quarter's expectation of $5.40 to $5.60. These earnings include $0.60 to $0.65 in one-time gains from special items. All in all, despite some end-market challenges, we expect to finish the year 2007 as a wonderful year for 3M; having done a great deal of fixing and rebuilding to accelerate growth, while maintaining our outstanding returns. We completely overcame the impact of sales lost from the sole pharmaceutical business and I think its testimony to resilience of 3M and its people that we seem to have done so with these. So congratulations to all of them. With that, I would like to turn the call over to any questions that you might now have. Thanks a lot everybody. Question And Answer

[Operator Instructions]. Your first question will come from the line Mike Judd with Greenwich Consultants. Please go ahead with your question.

Yes good morning. I have a question on the Display & Graphics area; I am just wondering if you can flush out a little bit more information near the issues around the mix shift from 720P to 1080P and also your comments about pricing and margin... I guess I would infer from that that you are basically lowering your prices as is typical in the electronics area?

Go ahead George.

Yes Mike, thanks for the question. What really started this was the plasma guys were getting a little nervous about their assuming inability to penetrate the market. So they lowered that process first. The LCD guys in the similar sort of display area then followed suit. And of course, it left the 1080 guys here in a position to sit with the process, will follow suit yet further still. So what tended to happen is growth then was spurred in the low end of the marketplace and that's sort of seen the rise of companies like Visio, you might have seen the data where they essentially went from nowhere to number one position in about nine months. So, lot of dynamics going on in this marketplace. But in realty what will happen in longer-term is I think obviously the upper end of the market, Mike, is going to respond and so a big growth right now is occurring in the 720 area of the marketplace. We have few products in that area and in order to unfold our concept of this optical engineering franchise that we have so many other places, we see a need to service that part of the market just as we service the top and so what it will mean is that we will be releasing products in the fourth quarter or the first quarter and the practical realty is that though real products are low in margins but I want to stress we don't see this thing going into any serious trouble. We still think that long-term the optical film business is going to have a margin comparable to or perhaps even higher than the company average. So we're relaxed at doing this. It will cause, I am sure, some turbulence and some concerns here and there, but we are very relaxed with this as we move in the market.

Just as a follow-up to that. If you would have think about next year in terms of revenues in that doses and you were kind of running through volume versus price versus mix, how would those numbers sort of, how would that work?

Well, I suspect that you are going to see some continuing pressure. When you mix it all together, what's going to happen, Mike, we are obviously going to see some significant volume pick up in the bottom of the market. But the margins there are less attractive than they are clearly at the top of the market. And the benefit that we get is we have all the capital in the ground, we have the technology. This is nothing new to 3M. It's in our absolute heartland. It's the kind of things that we almost do in our sleep and so we see some nice absorption lift in that bottom end of the market. But there will be a blended drift down, I think in the overall margins of that marketplace. But the key for us is it makes us far more important to customers, it makes us able not just to get the volume gain in the bottom but to secure the top and remain vital in this business to our customers.

Thanks for the help.

Your next question will come from the line of Deane Dray with Goldman Sachs. Please proceed with your question.

Thank you, good morning.

Good morning Deane.

Question just to stay on display if we could; could you quantify for us what the dynamics were in the quarter on the pricing decline and volumes specifically?

Yes, Deane the pricing is very consistent with what our historical trend has been and this is basically been offset by volume. But if you looked at that business, it would basically be flat kind of on a year-on-year basis from a revenue perspective.

And how about volume?

Volume would have been basic to offsetting price. So revenue will be about flat in that business on the year-on-year basis.

Okay. And then George just to... maybe its premature to quantify what the impact will be as you go down market on this and that was very clear last week at the analyst meeting why you are pursuing this from a strategic franchise standpoint. But when you say that that margin... it may be coming down to the company average or just above the company average, that could be pretty significant and what time frame should this... are you expecting this impact?

I think Deane this is probably a multiyear impact. Obviously, the volumes in these as we released these products, Deane, it takes a little while for adoption to take place so that may take one, two quarters or so. But I think this is a kind of thing that probably will unfold in the next 18 months. Probably will get eased as we get closer to the transition being for the high-def televisions, probably easing at that time would be my guess. But building volume and building market is significant for 3M. So we maintain that enforced in the marketplace and it's a very important marketplace. So I think this is not some precipitous thing that is going to happen next quarter, but I do think it is something we will see transitioning go over the next year and half.

Hey Deane, could I bring it back a little bit to maybe a couple of pieces of my presentation that I had where we were talking about the overall margins of the company. What we are telling you about LCD, LCD is very consistent okay, that we can manage the LCD business within the construct of the overall company margins. We have been anticipating that margins in that business will have to come down and as we showed you that the margins in other piece of business will continue to rise. So on a mix basis at a company level, I would not get excited by it. There's obviously a lot of growth.

Thank you for the color.

Your next question will come from the line of John Roberts with Buckingham Research. Please proceed with your question.

Good morning.

Good morning John.

Your comments on the consumer electronics industry and the Electro Communications segments, is that cell phone primarily or there are other consumer electronics that are affected there?

Well, the most significant issue we have is an application. Well, I guess couple of things, one is the application in inkjet printers, which I think you are well aware that that business continues to erode and that we had a very large business sector and of course that's just going to, eventually in the light of volumes, coming down significantly. And we did have a few other applications and some cell phone applications that of course have changed the design as well; so, both areas.

Okay and then the cell phone weakness hasn't affected at the optical films business at all?

No, not at all. We are still very strong there.

Thank you.

Your next question will come from the line of David Begleiter with Deutsche Bank Securities. Please proceed with your question.

Hi good morning.

Good morning, Dave.

George and Pat going back to optical films, ignoring the margin for a second, what is the new strategy implied for operating profit growth over the next two years, as you increase the volume and sales dollars? Do we see a sale where margins are down but operating profit growth is maintained at a fairly high rate?

I will try to tackle that. David, it's a great question. And it was some thing that we are looking at customer by customer, application by application. As George described in his presentation, what we wanted to do is make sure that we maintain the leadership position enhancement films across the entire segment. So, obviously we are trying to go after volume. I won't, at this point in time, not necessarily guarantee you that profitability will actually increase in the near term. But again I want to bring it back to the context of the company as a whole, the broad portfolio we have drives the double-digit growth that we have talked to you in the past about so... been part of our plan and we are going to execute to that. But I would not necessarily see that's in the near-term necessary that we'd see profit increase in that business.

But just to be clear, could we expect optical films profits to be flat in '08 versus '07?

Too soon to give you that forecast Dave.

And last thing, any signs of slowing in Europe?

No, not really, our European... I've probably seen the same pieces of data, that a lot of you have seen relative to some macroeconomic indications that... there maybe a crack or two in the system, but we have not seen in our business thus far.

In fact Dave, what we have been seeing in some places where we've been traditionally slow, consumer office where the growth wasn't so good, we have seen advancing growth in those areas. So we seem to be doing something which were offsetting some of the... if there are underlying tendencies along the lines that you're speaking about, we seem to be getting better penetration in some markets that's offsetting that.

Thank you.

Your next question will come from the line of Stephen Tusa with J.P. Morgan. Please proceed with your question

Hi good morning

Good morning.

Kind of a nitpicky question. What exactly happened in interest in other income? Kind it was like $50 million and that's up pretty substantially year-over-year, but also up from the second quarter?

Well, primarily because our debt levels were up pretty significantly. Obviously borrowing rates are up from last year, I mean that's a simple answer.

I think that's positive though. It's a positive $50 million, it's not an expense

I am sorry; you are telling income or expense or

It's interest in other income. It is a lien item and it's up... it's $53 million versus $13 million last year and --

I sorry, you are telling the income piece of this.

Yes I am sorry for not clarifying.

No I am sorry. I was just thinking of the net. Okay sorry.

Yes no problem.

But our cash balances are up, some of the returns that we're getting, okay are favorable on that side. We obviously try to look at the net impact of the cash and debt side of it. But it's a combination of the two. Our cash balances were up primarily outside the U.S. and some of the returns obviously we get in the marketplace were up than rather than there were the last year.

Steve this is Matt maybe we could follow-up after, if there is any confusion. But quarterly interest expense was 53 versus 37 last year.

Okay.

So it is up, that's up and interest expense was higher than last year as well, as cash balances are up.

The other question is George or maybe Pat, could you just maybe give us when you look at here other than Display & Graphics, what worries you the most, what are kind of the key variables and '08 would be great, but if you don't want to get into '08, yet maybe what are the key variables for '07... for the rest of '07 for the fourth quarter to hit your guidance, but what you are going to be watching over the fourth quarter outside of Display & Graphics?

Well I think it's much of what we said already Steve. In the consumer and office business, it's tighter in the U.S. there is no question about. They did well, the numbers show that they did well, offset by great growth internationally. So I think their numbers will grow side ways they will do just fine in the... the thing that we saw the last year Steve was in the industrial markets, in particular distribution, we saw a lot of slowdown toward the end of December and so we got to make sure we watch that and we are working very, very hard to make sure in the early parts of the quarter here that we don't get caught by that surprise at the end of the quarter. So that's an issue, because when you are feeding into distributors, clearly they have a lot more choice on whether to take or not to take. So that's something that we just want to make sure that we don't get trapped by as we did last year. And then it's some of the old faithful, it's probably the roofing granules business. But I mean I don't expect any big change in that from the third quarter. So its, Steve it's maybe consumer watch the industrial thing which and if you saw the industrial growth rates they were great, but just going to make sure that we continue those right through the quarter. We don't get tripped at the end as people sort go off vacation and that's probably most of it.

Okay and then one quick one. We look at all the capacity that's coming on line in the third and the fourth quarter list, that's starting up here. What gives you the confidence that the roofing granules remains pretty weak and you guys kind of add capacity there into the teeth of the downturn, I mean what gave you confidence that you are actually building the demand here and how concerned should we be with regards to that as we look forward in '08 given that you are spending so much in the next the third and the fourth quarter to get these plants up in running?

Well you had a couple of questions in there. In the roofing granules business Steve, we took out one plant in the Northeast, which eases some of the overcapacity and by the way we were supplying markets well in to the South from that plant that really sort of reversing in cost in that business last year. So that's gone away. In the overall housing market, I don't know there is any of this out here would withhold a lot of optimism in the immediate future for the housing. On the other hand you have seen what's happening now in our consumer and home improvement business. We are through penetration, through winning new accounts, through in some cases knocking out competition, getting penetration there and through new products like Filtrete in command, we continue to do that. It seems to be working okay for now Steve. So I am not negative on that business, but it will require the same execution, the same old 3M formula, lot of innovations, lot of new products into the channel to make sure that we remain stable in that business.

Okay and I guess in regard to the other capacity of all the capacities coming online whatever AR [ph] plans that your adding in the next two quarters, how comfortable are you that you are not adding this into this global slowdown that many are anticipating?

Well first of all, the vast majority of the capacity speed is coming on screen overseas and the plants are raised in such a way that you build the box, you only put enough production machinery into those plants that are appropriate to current levels of demand and then you obviously add to them as demand increases. So you don't necessarily carry all of the burden of the sort of an unfilled plant. But as a fact a matter Steve, the reality is when you have a plan that takes two years and you have a market that changes in six months, you have no choice but to sometimes build ahead and try to plan in a scalable manner as you add capacity and even if there are temporary dips in the U.S. market or even some parts of the international market, the reality is those will last six months maybe and we will be in a position to respond to the growth, as the money comes back and it will. So it's impossible Steve to time the opening of a plant and the exact addition of the capacity to follow economic circumstances. Just not... none of us have those kind of levers and that kind of refinement of finesse to be able to do that. So you do consume some of that.

Yes, Steve let me just add, those... especially, internationally; the plants are being stalled in, recall China, India, Poland, Russia with all have very significant yield. The developing part of the economy is just absolutely booming. So, most of the capacity internationally is going into the highest growth parts of the economy and still to-date.

Right. Okay, thanks a lot.

Your next question will come from the line of John Inch with Merrill Lynch. Please go ahead with your question.

Thank you. Good morning.

Good morning John.

Hello guys. Sort of interesting Pat, you hit your five year tax rate target this quarter. Anyway my question Pat actually is on, how much did raw materials, particularly given the price of energy drag this quarter and if not this quarter given the price, the rise of price of oil or does that going to be a headwind and perhaps a little color around that. And then the second thing would be just currency up 3.1% top line, what was the translation impact to earnings per share?

Yes John, on the material side. I think George had kind of mentioned commodity in your number of about $35 million impact in the quarter. That's kind of the headwind piece. I am sorry, what.

I'm just saying, does that get worst just based somewhat has been happening --?

Alright, I don't... who's knows again whether this is going to play out. But importantly, we have got a very, very active purchasing group that continues to... we see those commodity headwinds. In some cases you have got absorbed those and they got to go... you'll find other ways of getting offset. So, they are very much on-track of trying to manage our net material costs on a on a cost down basis, you can guarantee that we don't let him off the hook, okay in a tough commodity world or not. So, but it is a fact of business and I think what is great is even with... if you go back and look commodity prices over the last five years, I mean a lot of these things have doubled, tripled what they had been and yet our margins have continued to grow. So I think it shows the overall strength of the company. On your foreign exchange question, we have probably a nickel or so benefit here in the quarter relative to exchange.

And then just on consumer and office. Consumer and office, George was sort of a nice profit surprise given sort of what had been happening in the office retail channel of the U.S. Based on that outlook though is that business going to start to drag may be a little color around, I know you said it could hold together but I am just wondering more profitability of it, particularly given sort of what you see... what you saw with respect to back-to-school season and to sort of what the trend is there?

I think, John the mix of the business is going to change, I see no reason to believe that until the U.S. economy shows a little bit more robust trends that we will see much difference in the way that the U.S. consumer and office business unfolds and if you can't separate that into two pieces John, the office piece seems to be the weaker. Consumer home improvement which is in that segment, John you saw and the numbers did very, very well. Now the positive news as I said earlier was we seemed to be getting a real traction in consumer and office overseas. So net-net, I suspect that the performance in the fourth quarter is going to be similar to that that we saw in the third quarter. Of course we all know John, I think is you and I talked about it personally, what we really need is to continue to drive innovation but at the same time hoping and anticipating that we will see some turnaround sometime next year in the underlying end-markets for housing. But your guess is as good as mine on whether that happens in one quarter or later quarter. But all in all, John I am not especially worried about some terrible worsening of the consumer market. We seem to have been fairly adaptable in international markets and innovation that continue to drive that business and you are right to observe who have been doing quite well relative to some of the penetration of our consumers, of our immediate customers.

Hey John your kind of question on margins. We will be a little cautious. The third quarter in that business is usually the peak

Right.

So the volume peak as the margin peak. So just don't try to extrapolate that out for... in to the future, it is kind of a peak period.

Yes, now I understand. Thanks very much.

Thanks John.

Your next question will come from the line of Jeff Spraque with Citigroup. Please proceed with your question.

Thank you. Good morning everyone?

Hi Jeff.

Just back to D&G for a question and then kind of a general question may be on margins overall. But when you think about kind of this pressed into the low end, kind of defend your turf and drive the growth. Do you have share today with these emerging new low end OEMs like the Visios and some of these other players or is that kind of a virgin territory that you need to try to conquer?

Jeff yes we do. We do have penetration really in most of the applications as just to say a space of the price cost sensitivity at the low end of the market is more severe. So something that we just have to battle day in and day out and as George outlined last week, we are going to compete in all aspects of that market.

And I am just wondering if you not only think about margins overall, in fact, the model you laid last week is kind of understandable, kind of recycling the operating leverage etcetera back into the business; but specifically I am just wondering which businesses do you think have the most margin upside from here, if you are in fact going to look at 500... 600 basis points of margins down in Display & Graphics over the next 18 months or so?

Jeff, obviously this is an ongoing management... what the opportunity is, where we want it and invest and so forth, but I think it's fair to say that really across the company we have opportunities. One thing I laid out for you is, we still have opportunity as we leverage our growth rate into our fixed cost structure which really affects all businesses. So there's opportunity across all of them, but George and I have to really place bets on you, where we want to invest and so forth. And we do manage the company in total. So if optical needs a little bit of support because their margins are eroding, obviously, we have got to find offsets, and we continue to drive productivity across the organization. So generally speaking I would see we really have opportunities in all business. So it's a matter of... if you took that model I talked about, we have actually won that model featuring one of our businesses as well, we decide how much you want to plough back into margin versus growth, is something that we just actively manage; but I would say that underlying all of our businesses have growth potential there.

And I just wonder if you could give us a little sense to how you think about cash flow going forward; still some pressure obviously little bit on the working capital terms, accounts receivables were up on kind of softer sales. Is this still... I guess first that you can comment on receivables given sales growth is a little bit slow and then I guess the question of inventory turns kind of goes more to the supply chain issues but what we might expect going forward?

Jeff to me one of the good sides of the quarter when I look at working capital, total looks like we have stabilized the situation. So as I look on a going forward basis, we should basically be able to improve our performance as we continue to get our supply chain kind of square to round. On the receivable side the thing we have to be very careful of is you have to kind of see where the sales occurred during the quarter. They accrued more that towards the back end of the quarter. You end up with obviously more receivables on your books at the end of quarter than you do... if you look at more on an average on average basis. We have some receivable follow-up issues that we have to keep... you keep looking on. As our international piece of business continues to grow faster than the U.S. that actually hurts our mix a little bit because their turns are lower than what they are in the U.S. So we are very much focused on that. But if you look at it from a forward-looking cash flow projection, I think our working capital turns now. I feel pretty good we have stabilized the situation and that should now provide leakage on a going forward basis.

Okay, thank you.

Thanks Jeff.

Your next question will come from the line of 31-34

Your next question will come from the line of Shannon O'Callahan with Lehman Brothers. Please proceed with your question.

Good morning guys.

Good morning, Shannon [ph].

Sorry to keep you on optical here, I am sure you are sick of hearing about but, I just want clarification; on when you talked about... you still think its, a business that can have company average margins are better, it sounds like there was an optical comment not for the whole segment. I mean, would that imply that the whole segment you would see is lower than the company average?

No, we were not trying to imply that at all.

Okay. So, I mean if all D&G, you were at the company average obviously, optical, you still think can better than that?

I think that D&G are the mix basis will not drift too far away from what the company average will be longer term.

Okay and then I guess just, if I could understand the growth there. You took down the growth target for D&G when we were in St. Paul and if you are going to have market, shouldn't the volume accelerate, I guess the price pressure obviously, is much more. But, I mean, can you give a sense of... when you are adjusting whole segment there, is that really driven by optical in terms of the downward revision?

Yes, I would say the...at least in my thought process is that entire revision is really related to optical and I will say it's probably more so of two aspects, one is the mix of the business is with our volume expectations, we haven't changed all that much relative to TV projections from end-market perspective and then, probably our assumption relative to the prices is more aggressive than we previously had.

I think Shannon, we expect a million questions, but obviously there's a lot of dynamics in this market place. What is likely going to happen I think in the near term is we will see at not just in the lower segment, but even in the higher segments, there'll be continued margin pressures, continued pricing pressure. But the challenge for the company is to kick into absolute high gear all its activities are double write, double speed, yield improvements, as a means of offsetting that kind of pricing pressure. Now will we... what we net-net be able to offset all of that, I suspect there'll still be some net negatives that come of it. But the beauty is that as this sort of this battle unfolds and we fought this battle and seen this battle many times in our history. It's likely to go on for the next year and a half and then there is relief at hand, which is in the change to the high-def televisions which would probably ease some of the pricing pressure and will probably move the market back up a little bit, it would be my guess towards the 1080P. So we will benefit again from that, but as this... and then maybe stability perhaps, obviously more capacity coming on-stream as demand increases. But probably relative price stability for some time and then this market by that time will have captured 60% to 70% of the TV volume in the world, which means it will then probably ease in and evolve into a much, much more stable market for the future. That would be the way that I would read the kind of the ups and downs of this market over the next 4-5 years. Matt do you have any opinion?

No.

So long term we are genuinely very positive about this market. It doesn't mean in the short run we won't have some hand-to-hand combat we always do and especially a tougher economic times, where people are very sensitive to price. But all-in-all it seems like a great market and we have the capacity, we have the technology, we have the will, we have the customer contacts to be able to make this the kind of great business that you have in many other segments of our company.

And just last one from me, thanks for that. Just getting from sort of the, in the growth rate you saw, this quarter you mentioned not everything went right, but I terms of getting sort of, it backing to that 5% to 8% percent range and maybe towards the higher end when we will. What are you are really looking at to drive that acceleration.

It was much of the same stuff that we have been doing before. It's getting out, plants sold very close to what to new customer demand and getting filled rates up, that will lift part of what we are doing. The new product machine seems to be in top gear right now. We are spending a lot more money on R&D. The new product vitality index is going up, so this stuff is speeding into the market place and in the end it is product which is a solution to the problems. In particular, if you just take a look at a segment that we have talked about quite a lot today, the consumer and home improvement segment, which is really, was originally kind of a paint and dry wall business. As we added to the portfolio in that business with filter products, with more adhesive products, it took the edge of some of the pressure off that we might have seen in the traditional core, and we will continue to do that. So it's the plain and simple answer that innovation remains the key.

Okay, so sort of the broad strategy, particular segment that's going to do it, it's going to be served across the board based on what you have put in place?

This is happening all... right across the company. We are not pointing to anybody.

But there wasn't anything in this quarter which particularly you saw that we expect to be the one sort of... one that kicks up, just sort of the broad strategy coming into effect?

Yes. It was as we said there was just continuation of the roofing granule stuff that we've seen now for, for a year and you know the shift within the optical business and a little bit of the U.S- based consumer, they were the things that were dragged, so many of the positive things came through. It was interesting that the words that we used on the growth, a company of our size having 9.4% growth in the quarter is pretty spiffy nevertheless, no matter what we say.

Okay. Thanks a lot guys.

Thanks.

Okay well thank you very much ... Go ahead.

That concludes the question to the answer portion of our conference at this time we will turn the call back over to 3M for some closing comments.

Well thank you everybody for joining us this morning, I'd just like to reiterate that while there's lot to do yet, our plan is on-track and we are confident in our ability to execute it. So thank you very much for listening. We much appreciate it. Thanks everyone.

Ladies and gentlemen that does conclude our conference for today. You may all disconnect and thank you for participating.