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George W. Buckley - Chairman, President and Chief Executive Officer

Patrick D. Campbell - Senior Vice President and Chief Financial Officer


Stephen Whittaker - Sanford Bernstein

Scott David - Morgan Stanley

David Begleiter - Deutsche Bank

Jeffrey Sprague - Citigroup

Shannon O'Callaghan - Barclays Capital

Clifford Ransom - Ransom Research

John Roberts - Buckingham Research

Martin Sankey - Neuberger Berman

Charles Harris - Ridgecrest Partners

[Melissa Cook - CLSA]

[John Flannery - Portland House Advisors]

John McNulty - Credit Suisse

Bruce Babcock - Saybrook Capital

[Craig Evander - PCM]

[Eliott Fructer - Galeon]

3M Company (MMM) Financial Guidance Call December 8, 2008 1:00 PM ET

George W. Buckley

Good afternoon, everyone, and welcome to our meeting here in New York. We're glad to have the chance to give you an update on what's happening in the fourth quarter and also our preliminary thoughts for 2009.

What I'll do today is I'll give you some preliminary comments, opening comments, on our perspective and our approach to the business during these very strange times, and then Pat's going to go over the numbers in detail with you in just a few minutes.

You know, in these times, it's very important for people like myself and Pat and others to remain very positive, even if we're still guarded about the conditions out there in the economy. Now all of you know that I'm not an economist, so it's pointless for me speculating where the economy is going to go from here. And even if I could predict it accurately, you wouldn't know what it was like until after the event, so the chances are that you wouldn't believe me anyway, even if I was right.

We all know that the economy is bad today, that it's likely to be bad for some time, and I think perhaps some of us having an inkling that in some segments of the economy it's going to get worse before it gets a little bit better.

Nobody out there in the world, whether it's in the government or whether it's in industrial companies, really have any experience. Nobody's lived through times like the ones that we see. And clearly, from what we're seeing, fear is a big factor out there in the economy. But I would like to plead for a case here that oddly enough Pat and myself have both experienced these kind of downturns in our former industries and, while they're horrible and while we don't like them, they're well within the range of experience that Pat and I have come across in former times.

Here's a little bit of a sort of selfish point of view, but this is a time of figurative self-preservation for companies, and that means that there's a need to preserve cash, to conserve cash, and to cut costs aggressively, yet at the same time cut them in such a way that we're doing sensible things and not injuring the underlying strength of the company.

We've been going through, in our company, vigorous downsizing, better prioritization, deferring pay increases, eliminating temporary workers, eliminating overtime, taking furloughs, stopping some nice-to-do things, and making policy changes that in the end will permanently reduce costs at 3M. So all of these things are very, very helpful to us.

So we're doing all the things that you'd expect of us and more besides - trimming assets and using the pickup in those assets to spend on restructuring. It might surprise you to know that in the last 18 months we've closed around 15 plants in the world, and we've worked that into our numbers as we've gone forward. We've also been drawing down inventory, cutting capital spend, shutting off inbound raw material.

So none of this is new actions for us, even though you've just learned about some of it. It's not new actions for us. We've been doing it for over 18 months. We got an early - because Pat and I had the view that there's no medals being issued here for being behind on the cost cutting curve.

So is this helping? Well, yes, I think all of us acknowledge that we're collectively making the situation worse, but I think the first responsibility we have as leaders of companies is to make sure that we ensure the health and survival of our own companies first, not necessarily other people's companies or, for that matter, the U.S. economy.

But on a more positive note, we still believe that survival is not enough. As my grandmother used to say - many of you know quotations from my grandmother - "It's a ill wind that blows nobody any good," she used to say. So 3M intends to prepare for the worst the way we'll structure ourselves, yet at the same time driving for the best, because we think there's still some positive things that can come out of this particularly troubling time that we see right now.

I also observe in history in my own experience that in the actions of any financial disaster like the one that we have today is born the opportunities of new profits for somebody, and we certainly intend to be in that queue.

But what do you do at times like this? You have these cataclysmic falls off in end markets. You have layoffs. You have fear running rampant in many marketplaces. What do you do at times like this? I'm going to paraphrase George Bernard Shaw, who said, "The best way to predict the future is to create it." And to the extent that we can, we still intend to go down that pathway. We still intend to take control of the things that we can take control of and create the best future that we possibly can.

He also had another line which I'm going to paraphrase here. He said, "Sooner or later, those individuals and companies in life that win are those who think they can." And we certainly plan to be one of those.

I'm going to tell you a little homily now that happened to me back 11 year ago. I own a house in the U.K. You all know I'm from the U.K. I was on vacation there and I was shopping at the grocery store  and I'm not going to make this story long, I assure you - and I was looking for some milk. I went over to the frig and I reached inside the frig door, and I saw this carton that I'd never seen before. It said 98% fat-free milk. Just momentarily I said to myself, "What the heck is 98% fat-free milk?" Well, three microseconds later I computed it. Ah, this is the stuff that we call 2% milk in America.

It planted a seed in my mind that, you know, in downturns, which we were going through at the time, that when there's a 2% downturn, there's 98% of the market left. In a 5% downturn, there's 95% of the market left. So the important thing for companies like ours is to focus on the 95% that's left and not on the 5% that's gone or the 98% that's left, not the 2% that is gone. And this, I think, is a different perspective, a more positive perspective that you can have at a time like this. There's still an awful lot of the market left.

So the question is really how do you get at that 98% or that 95% or whatever the number turns out to be? And from my perspective the objective there is to design products which are so clearly differentiated from the competition, so clearly separated from them in service, so distinct that the choices that the customer has are obvious. They're going to take your product, and you're going to end up with the lion's share of the 98% or whatever number it turns out to be that's left. You're going to try to make your products clearly stand out from the competition.

Two of the great temptations for corporations - and there are many temptations for corporations, but two of the biggest - are to let costs creep into your corporation when times are good, and to cut R&D and sometimes advertising and merchandising when times are bad. Now, one should never say never in life. I think that's a dangerous thing, to say never. But we intend as best as we can to hold our R&D spending intact, at least as a percent of sales, for as long as we possibly can.

I'm reminded at this juncture of a speech I gave in Chicago some years ago. And in the question-and-answer session at that meeting in Chicago, I was asked the question: Yes, but George, what if we continue to pay for all this planning in our company and the people leave? And I made the point, what if you don't and they stay? The same principle here applies to innovation. What if you don't innovate and you don’t have the opportunity to differentiate your products? You're just going to become a hostage to fortune.

So in our view, it still remains very consistent with all that we've said and all that we've believed heretofore, that innovation is our best chance - perhaps even our only chance - for success in times like these.

So how and where do you innovate? Again, I've said many, many times that the best place to innovate is in the core of your business. It has the lowest risk. It has the fastest returns. You know the market. You know the product. You know the competition. You know the technology. So that's what we intend to do. We intend to stay the course on innovation to the best extent that we can.

But obviously you come across businesses that need harvesting, and I would only remind my colleagues in the audience here there's a very big difference between milking a cow and starving a cow. So clearly don't sort of transition yourself into the major buggy whip manufacturer in the world.

So condensing all of that, we think that we have to continue to innovate to survive, let alone prosper, and if it's not evident to all of you out there, this has always been 3M's secret, deadly weapon - innovation.

It has also become a power inside 3M right now and, you know, if you think about it, perfection is the natural assassin of production, so it's important to get the stuff done, to get the stuff out, and let the market see what you have to sell. There's nothing quite so demoralizing to a competitor than to beat them to the market with a product at lower cost and then for them to see a river of new products streaming out into the marketplace and having to deal with it. Nothing quite so demoralizing to a competitor as that. And luckily, in the last three years we've been preparing quite a bit of this and have quite a bit of this ready for launch.

So what really is going on here is a sort of a Darwinian process of economic natural selection. I think it's not going to take a strong leap of faith for anybody to realize that the strong here are going to get stronger and the weak are going to get weaker. There are going to be huge dislocations in value and opportunities for acquisitions are going to pop up. Bankruptcies are going to happen. Consolidations are going to take place. Easy steps into adjacencies are going to become possible. And as you've seen in banking, it's going to happen fast. So companies need to have thought through the chances, through the choices, through the opportunities, and be well prepared, because chance always favors the prepared mind.

So we believe that 3M's strategy of focusing on the core, selectively investing in growth, is still appropriate. We intend to do that in China still, probably in Latin America still, and back here in the U.S., both in solar and the water infrastructure. Vision without action is a daydream, but action without vision is a nightmare. We intend to make sure those things are coupled properly.

So what do we think is going to happen now from here on in? Clearly, being a short-cycle company, we get hit the fastest with inventory turns, or inventory corrections, I should say, take place. We also recover the fastest, and we think this is what's going on in the fourth quarter.

When they happen, risks of wholesale decline are always a multiple of point of sale decline, and typically we need an inventory turn at end markets for changes to work through the system. And if you add to that the sort of seasonality that we see at Christmas, this could go on for another quarter, perhaps quarter and a third. It's hard to know.

So I think that these sharp declines are going to go on for a little while, but eventually will moderate and bring wholesale and retail in line with one another as the coming year goes on. And Pat is going to go over a chart with you that will show you how we're thinking about that particular activity.

As a practical matter, we can't change our stock price or, individually, can we repair the economy, but we can do some things, we can affect certain things. We can work the operating and competitive fundamentals of our company so when saner times return we're a better and fitter competitor in the marketplace. We intend to keep our eyes on that price of growth and that prize of a better competitor, sort of in a way sort of like having one foot on the accelerator and kind of one hand on the emergency brake.

This is time for prudence, but it's not time for surrender. On the other hand, the fight to be competitive is never over. We can never relax and we can never be complacent, and we won't be. As my hero, Churchill, once said, "The end is only the beginning." The end of this is only the beginning of what comes next.

So we think that the model that we've been following the long-term approach to our marketplaces, investing and building in the core, making sure that innovation is still sound and robust, making sure that we serve our customers absolutely superbly, driving cost out in the company, conserving cash, preparing, as best as we can, for the opportunities that are going to unfold in due course - I have no doubt about that - trying to make sure that when they do we can be speedy about it. These are the kind of things that are going on in our company.

And Pat will also explain in just a few minutes, we are in the business of obviously constructing sensible scenarios for the future, trying to prepare for the worst, but at the same time driving as best we can through costs and growth to prepare also and seize the best when it comes along.

So with those opening remarks, I'm going to turn over the podium here to Pat, and Pat will fill you in with the details on all of the numbers. Thank you very much, everyone.

Patrick D. Campbell

Are you guys chilly enough? I'm not so sure if we're piping in cold air from the outside here or not, but thanks for showing up. It's a good audience. We weren't exactly sure, once we sent out the press release, how many people would actually show up or not, but we appreciate everybody's interest in the company.

What I plan to do is take you through - and I'm sure everybody's already read all the material, okay, which is always one of the dangers of passing it out - so if you could try to pay a little bit of attention to what we're going to say to some of these, some of the messages along the way.

I'm going to cover the fourth quarter - first of all, let me go to the forward-looking statement. Everybody's aware of this. It's in your handout. This gets longer and longer, and we always run into new things, okay, to kind of put in the forward-looking statements. And especially these kind of times, it is very, very difficult to anticipate all of the changes going on.

So what we plan to do today is take you through our '08 finish to this point in time, what we know. Kind of risky to do. December's not over, and so we'll give you our best view there. I'll talk to you about our scenario planning around 2009 and then summarize, and then we'll take Q&A.

So let's hit 2008. First of all, let's go back to what we said at the last earnings call, which seems a long time ago now, October 21. The point here is that what we had was a full year guidance of $5.40 to $5.48, margins of 22.5% to 23%, tax rate and CapEx. We were looking at some more restructuring, and we think we've been ahead of the game on restructuring actions. I'll cover a slide on that as we go forward here.

So first of all let's just talk about what we're seeing here in the fourth quarter. October - and that was kind of the context of when we gave you the call - October sales were a little soft. Profits were in line with our guidance. Organic local currency sales were down about 3%, which was a little bit higher than what we'd expected. Currency was down 5%, which was larger than we had anticipated. But our profits were in line so, at the end of October, things were in decent shape.

November was a rapid change in business conditions for us across geographies and across business units. Organic local currency sales were down 17% in the month of November. Currency was down another 6%, so you can see the top line revenue number's significantly impacted here in November.

In December, highly uncertain, but it's hard to say that conditions will be much different than November, so that's the way we're thinking about December.

And, as George said, this is a very, very unusual correction that's going on right now, a very, very rapid change in customer demand. I think people started to respond to look at what October was like for many of them, started to adjust their production schedules accordingly. A lot of them became very concerned about their own creditworthiness, the availability of credit.

And basically everybody is in this, as George said, you know, kind of a hunker down mode of trying to preserve cash. As we talk to a lot of customers, they would much rather be out of inventory at the end of the year rather than have excess inventory around, so it's very much of a different game, obviously stemming from the origin of this being, of course, the financial crisis, which really affected the entire global economy.

So here's 2008 as we see it: For the fourth quarter, this chart lays out our thinking going into the quarter. Our organic revenue growth was minus 1% to minus 2%. Our foreign exchange, we thought, was about a negative $0.02 to flat. And the margins and tax rate are what we're showing there.

So here's what's happened: The volume change, which is minus 1% to minus 2%, now down to 10% to 12% for the quarter. And again, remember, October was not a bad month at down 3%. So that's worth about $0.22 to $0.25 net of some of the cost reduction activities that we've had in the quarter. And again, remember, December's not done, so there still is an estimate here.

Foreign exchange is now about $0.08 versus where we were, and I'll cover this a little bit later on currency rates, currency rates that move very rapidly through the month of October here and into November and then, obviously, here in December.

You look at now our margins, where we were versus where we're forecasting to be, 21.5% to 22%.

Our tax rate is actually down a little bit based upon some of the lower pre-tax earnings for the year.

So that's kind of where we're at. Not included in these numbers are some restructuring actions that we are currently under way with, and I'm going to give this to you as an estimate, realizing that the month's not over. We still have some more work to do here.

We've reduced about 1,800 positions internally that we've announced, and that actually came out over the weekend in a few press articles and in our press release. Subsequently, we've been working on an additional 500. That primarily impacts the international piece of our business. And we're still working on possibly more depending upon business conditions. So right now we're at about 2,300 for the fourth quarter. All geographies are impacted, but the heavy focus is really on the developed economies  the U.S., Western Europe and Japan.

As part of this action, we're going to rationalize 10 manufacturing, technical and office facilities. In many cases these are plans that we've had on the drawing board here over the future couple of years and we're effectively pulling these forward now and getting them down, in many cases by the end of the year and in some cases early next year.

So the aggregate cost is $215 million, which is about $0.22 a share, with a cost savings of $225 million as we go into '09.

Importantly, as we look at severance plans, our objective is to achieve about a one year payback or less on our severance plans. We could actually probably get more people out, but it would be a lot more costly to do that, so we've got a balance here between, you know, cost and return.

So, with that backdrop for 2008, let's just talk about 2009 or kind of how we think about scenario planning. And I must say that, as we went into our planning process in, say, this summer/fall period, the world was somewhat different, so we've obviously had to modify our thinking as market conditions have kind of played out here.

Importantly, though, we need to adjust to a lower growth economy in the short term while maintaining our long-term growth focus. We need to keep an eye on that there really is a long-term objective here that we want to drive to. So the changes we're making organizationally, restructuring, investment-wise continue us on the path to where we want to be long term.

In these kind of times, cash optimization becomes even a higher priority for us. Our whole thought is to plan conservatively and preserve cash. Capital expenditures will be less than $1.2 billion next year from $1.3 billion to $1.4 billion this year. We'll have a much tighter acquisition screen, minimal share repurchase activity, a very disciplined AR management approach. For our businesses to even consider giving any kind of extended terms, it requires a much higher level approval in the company. We're not going to use our balance sheets to bail out our customers.

Very careful demand planning during these times to make sure that we don't get our inventories out of whack.

We are going to face in there some headwinds in 2009, and I'll cover all these - organic volume growth, I'll take you through a bunch of scenarios that we've looked at; a pension headwind for next year based upon our current thinking; foreign exchange is definitely negative based upon current rates. We're not trying to predict where rates are going to go, so what you'll see is using November end rates. We will have a higher net interest expense. I'll take you through the logic on that.

But yet there are opportunities for us, and to run the business better we're going to continually go after market share gains. We've already talked about restructuring, and I'll cover this some more; productivity programs. Raw materials, I'll cover this. And that, as George mentioned, we're doing things on the compensation side in the short term, deferring some annual pay increases and actually modifying work schedules where we can, to make sure that we're driving cost out at the same time.

But importantly, in our planning mind-set what we're trying to do is to drive sufficient cost reduction to really offset the volume risk that we see in 2009.

So here's kind of the headline numbers that are in the release in your package. Organic volume, we'll take you through a couple of scenarios here, of down 7% to down 3%. Foreign currency is down 6% to 7%. Earnings per share are down 3% to down 12%. Our objective is to have margins steady from 2008 into 2009. And free cash flow will approximate net income, however, I must give you a big caveat. Depending upon where we end up at year end on our pension funding situation as well as some of the severance funding, as to what the timing of that will be, are a little bit of wild cards. But other than that, it should very much approximate net income.

So the first part of trying to put together the plan is looking at volume, which is obviously the most uncertain part of this whole scenario. So what we've tried to do is look at a number of different things. We looked at economic forecasts. We looked at how did 3M perform in prior recessionary periods. Of course, we're taking input from customers, and, of course, the input from customers right now is not worth a whole heck of a lot, okay, just because, obviously, they're constraining their thinking.

Our general view - and this happens to be once source, called Global Insight, up here - is this is an IPI forecast, which is one of the ones that we keep a close eye on, and they basically have a Vshaped recovery here. We have a tendency to think that it's probably not going to respond that quickly. And if you look at the right-hand side, a number of economic forecasts on IPI have kind of flat to down a little bit. Our view is it's going to be worse than that. We actually think it may be as bad as down 2% to down 3%. So we're actually planning for a softer economy than where some of the economists are right now.

And I think part of this is a reflection of that. I think it's taken awhile for some of the economists to kind of catch up to the trend of what's happening. We're seeing a lot of this a lot more current with some of our customers.

As I mentioned, we looked at the last recession. Now, I'm not going to take you through the

'70s, '80s and '90s. We went back and checked the data at that point in time - how well the company performed and so forth - but we didn't find it quite as relevant. And I'm not trying to hide it from you; as a matter of fact, what it would say is it would probably outperform the economics relative to that point in time.

We thought the most important point was kind of a recent period, which was 2001-2002 just as kind of a relevant point on how the company performed, and there's a couple of pieces that are in important in this. One is we have a tendency to precede the downturn, at least the announced downturn in the economy. And on the flip side, we actually have a tendency to come out before others do as well and that's an important fact.

But what we looked at here is we took the worst four quarters of the 2001-2002 period. At that point in time, global IPI was down about 3% and our performance was down 5% to 6%, so that was one data point that we looked at. You can see our performance in red there versus the worldwide IPI.

As I mentioned, we've been experiencing a slowing economy for some time. Some people have actually been somewhat critical of our '08 performance, especially our U.S. performance, because in some cases we've had negative performance in 2008. And the reality is we were seeing a slowing economy before it ever was officially called a slowing economy.

So towards the tail end of 2007 what we were seeing was: In the U.S., office retail was down significantly, housing was impacted and, of course, the automotive OEMs in the U.S. And, of course, the automotive OEMs have continued to get worse. Japan was slow and Korea started to see some slowing as well.

As we go through 2008, it became obvious in the telcom space around advertising and industrial as well as Western Europe on a broad basis, across the euro zone. It became very clear that they were in a slowdown mode.

And then, of course, when we got to the third quarter, fourth quarter here, with the credit market crisis, the economic slowdown has spread rapidly across almost all industries at this point in time.

And as I said, it's important that just recently, of course, the government did announce that we were in a recession starting in the fourth quarter of 2007, and I'm glad they finally confirmed what we were seeing. But importantly, we do expect on the rebound that we should be able to come out of a recovery faster.

So let's take a look at how we looked at modeling our '09 forecast. I'm going to start with the 5% volume forecast, so effectively, we've got a 3% to 7% range, we'll start kind of at the midpoint. Our thinking is that more than likely, with the fourth quarter being down 10%, that the first quarter will probably be very much like it, that it will actually take two quarters for orders and production schedules to get in line. As George said, it's about one inventory, give or take, that has to kind of work its way through the system. And then what we do is see improvement in Q2, Q3 and Q4. And, of course, give you a 5% for the year.

Now, when you look at Q4, I want to remind you that that's coming off of a 10% here, okay, in the fourth quarter of '08, so this is still actually kind of down a little bit from a growth perspective but, again, coming off of a 10% here in the fourth quarter.

So if you look at a 7% scenario, more than likely this would continue to have a very slow first quarter. It takes you to 7% to 8% here in the second quarter. And a gradual improvement, but it still says by the end of the year we're down about still a negative 4%. Now, our mind-set is from a planning standpoint that we're planning more to a 5% to 7% down scenario.

Now, if you look at a 3% scenario, what this would say is that fourth quarter's the worst it's going to be, and then what you're going to see is a gradual improvement in the first quarter, second quarter and third quarter. What's hard to believe right now is that we do think that the first quarter is going to remain very sluggish, more like the trough scenario.

So we have looked at kind of a 3% to 7% range, but importantly, our mind-set around cost reduction programs and planning is really around the upper end or the 5% to 7% range as we look at our forecast here.

Now, all is not lost in the economy. There are pockets of the economy that will actually have some growth to it. You'll see heavily on the IPI side that most of these slowdown and negative numbers will appear in the developed part of the world. You'll actually see some growth continuing on in the other Americas. I'll come back to Emerging Europe here for a second. The Mid East is actually going to go down, obviously, because of commodity prices. We actually think that our business can do reasonably well because we're so under penetrated right now. And then of course other Asia-Pacific, which includes China, as an example, would have continued growth to it.

The one that I'd probably have a little bit of odds, to be honest with you, is Emerging Europe. I actually think Central East Europe is going to continue to be sluggish through '09, and what I'll show you here in a second is what they've got built in as kind of a back end recovery, which could be at risk here.

So growth is slowing every place, but importantly, there still are growth opportunities to be had. And importantly, we're going to continue to fund growth opportunities in markets that we see have opportunities for the long term.

Our emerging market business is a lot bigger than it was back in the '01-'02 timeframe. Back in '01 it was $2.7 billion or 17% of revenues. Now it's about $7.5 billion or 30%, so it actually is a bigger make up of the company. So absent a significant alteration here, we do actually think there's some opportunities here in the emerging markets in '09. But by definition with the emerging markets, we have to keep our eyes and ears wide open to what's happening there.

Here you can see an example in Central East Europe, that what they show is a recovery starting after Q1, and I just don't quite buy that yet.

So if you roll those forecasts together on organic volume of minus 3% to minus 7%, again recognizing that the fourth quarter is a minus 10%, okay, so keep that in mind, there's effectively, on an '08 to '09 basis, we're forecasting to be down about $0.30 to $0.70, depending upon which scenario you want to pick. But again, our headset is much more towards the bottom end of that range as we currently see the business. Developing economy is expected to have positive growth again, albeit at lower rates, which we already talked about, and all the developed markets will be slow.

Now, foreign currency. Foreign currency has been a friend of ours for some time, really through the 2000 period. As you can see, on this basis, effectively you see that this is kind of on a market basket basis, but effectively a dollar weakening story. And you can see what's happened here most recently, since the third quarter. You can see a dramatic fall off in rates. So if any of you aren't paying that much attention, here's just an example of some of the rates that we're currently seeing.

And again, we're not trying to forecast rates. We're just taking spot rates as of the end of November and using those. We try not to get into trying to add that variable into our planning.

You can see that the euro's gone from $1.47 on average in '08 down to $1.29. And you also see that the China yuan's - but RMB has gone 6.92 to 6.83. You can see the yen's 103.5 to 95.2. And you can see the Brazil currency, 183 to 234. Canadian dollar or [inaudible] has kind of weakened. The pound has weakened significantly. And, of course, the Korean won has weakened as well.

Now one of the challenges we have is that a significant part of our manufacturing is in the U.S. and also we have a heavy manufacturing content in Japan. So right now, if we don't do something, on a year-on-year basis we'll actually get hit by both top line conversion of translation as well as some transaction losses as we go through the year.

So using November rates, where we're at right now is $0.45. That's our estimate. The top line will be down 6% to down 7%. We do, as I think we've reminded you in the past, we do hedge about half of our foreign currency exposures on a kind of rolling 12-month basis. But even with that, we still have a $0.45 headwind going into 2009.

So those are kind of the two big negative or headwind areas that we've got going - volume and foreign exchange.

Restructuring. So now we're going to get to the cost side of this. We're going to take you three categories. On the restructuring side what we're looking at here is a benefit of $0.25 to $0.30. We're continuing to assess our rebalancing our structure. During 2008, we're [doing] about 200 people out in the second quarter, 900 in Q3, and 2,300 people here in Q4, so over 3,000 people.

And importantly, we are trying to stay ahead of the situation. We're consolidating facilities where we can, and more than likely there's going to be more restructuring in 2009. The exact number we'll obviously give you as the year goes on, but we already know there will be some more in the first quarter.

Now let's get to kind of raw material selling prices. Our objective here is to try to manage the relationship between our market prices and our raw material inflows or commodity prices. I think on the material side, those of you that are at all following material companies or commodity companies have noticed basically a significant fall off in commodity prices.

Now, we're on a FIFO inventory basis, so it's going to take us awhile to get through our inventory layer to actually get the full benefit of lower commodity prices. In some cases we have longer term contracts with many of the suppliers as well, so we probably won't see the full benefit of commodity price reduction until towards the back half of 2009.

And my guess right now is I would say that probably our estimate, if anything right now, is probably conservative here on commodities. It's pretty hard to forecast these right now. We're not necessarily thinking that the current prices are going to stay the whole year. We've probably ratcheted those up a little bit.

The selling price, what our objective is to try to hang on to our 2008 price increases. We really don't have new price increases going into the market necessarily in 2009. Our objective here is to try to hang onto what we already have in the marketplace and try to balance that, obviously, with our market share and our volume, as we just showed you.

Now, normal productivity, this is what we do day in and day out outside of the restructuring activities. We've got another $0.20 to $0.25 here on profitability improvements. We've got what we classified as indirect costs of about $4 billion. This is basically costs that we pay outside suppliers for non-productive material. It could include travel, freight, utilities and so forth.

We will aggressively go after further reducing our indirect costs here in 2009. We've got a great Lean Six Sigma program across the company that continues to benefit both our supply chain and manufacturing operations. We will continue to redesign our employee benefit programs, and we've got a very good G&A cost containment program that's added a lot of margin to the company over the last couple years. And as I previously mentioned, we are doing things like deferring annual pay increases and modifying work schedules to keep this side of the cost equation under control in these very difficult times.

Now, pensions. There's probably a little bit of danger even giving you a number here because we won't know the precise answer until we close our books at year end, so we'll probably give you an additional update on our first quarter - I should say our year end call. But this is a rapidly changing world for us, which I know all of you are fully aware of, those of you, obviously, who are watching the markets day in and day out, living it.

We were fully funded through the third quarter; we felt pretty good about that. But obviously fourth quarter market returns have put a lot of pressure on asset values. We did contribute $200 million to our U.S. plan in 2008. More than likely, if current corporate credit spreads hold in the market, our discount rate will actually be increased from last year, which, of course, is key when you look at the funded status of the plan, where you obviously look at the assets and the liability side.

We have no mandatory funding obligation, so that's not a concern I have. And importantly, effective in 2009, all new U.S. employees are effectively in a DC plan. So we've cut the tail off of the long-term obligation there.

Now, on the net interest expense side, we see this going up $0.05 to $0.10. We think this is a solid move for the company. This basically is taking some of the short-term CP debt that we have and converting that to some term debt. We had two offerings here, one in August and one in October, at very favorable rates in today's market. A couple, 18 months ago I probably wouldn't have thought so, but in today's market these are very, very favorable rates at 4 and threeeighths and 4.5%.

So what we did is provided certainty around our debt structure in today's uncertain times, and then on the interest income side we really expect that, to be conservative, that interest rates will be relatively low relative to what you can earn in the marketplace. So that's going to add $0.05 to $0.10 for us.

But we think this is a solid trade for us. With the solid balance sheet that we have, we want to keep the solid - first of all, our debt rating in place, as well as we want to keep our firepower going here.

Now, if put it all together, this just kind of looks at putting all the pieces together, and I'll bring up share count here in a second. Again, our emphasis here has been to drive productivity and cost reductions sufficient to cover the volume risk.

But in this particular case you're going to find when I throw share count in here as an example, which is a favorable $0.08, we'll end up with an estimate of $4.50 to $4.95, which is the EPS of down 3% to down 12%; that if you take the productivity type programs, these thus far are able to offset our volume risk in the plan, where you look at '08 to '09. What's kind of got us hanging out right now, of course, is the foreign exchange piece.

So at this stage we think this is the best forecast we can give your relative to a top line of down 3% to down 7%, and then a bottom line of being 3% to 12%.

Now, to wrap up I'm just going to come back to the chart I had the beginning around our planning mind-set. Again, we're trying to manage the company for the long term, recognizing that the economy's going to be very slow here in the short term. So the restructuring actions that we're taking in facilities are ones that we would have taken anyways longer term. We're effectively pulling those forward to the best of our ability.

The restructuring related to people are people that, under almost any economic scenario, we wouldn't be brining back. These are restructuring of organizations to actually downsize permanently.

Cash is going to be far more important on our list as we go into '09. It's always important, but it really is kind of the king here and queen of 2009.

We know we've got some headwinds that we're trying to face into. I'd be fooling you to say that we have great forecast ability on the volume side. What we've tried to do is bracket our range around our performance, where we see the economic forecast going, and how we think we can perform in that. And hopefully I'm dead wrong; I actually hope the economy performs better than any of the scenarios outlined. But again, we're trying to go towards the higher end of the negative volume range.

And then we will continue to drive the opportunities. We'll continue to drive our market share gains where we can, and I think in the market we're going to be surprised in 2009. I think there's going to be a lot of market share opportunities for us, because I think the strong companies will actually win out at the end of the day, even through 2009. And we'll keep focusing on many of our productivity efforts.

So I guess, with that, I just want to kind of wrap up. And then George will come back, I think, after he takes his restroom break here, but I think I cut him short on when I was going to finish. So with that, I'm more than happy to answer questions, then George will join me.

I guess I have to announce the rules, too, right? Announce your name and affiliation for, obviously, the record. Thank you.

Question-and-Answer Session

Stephen Whittaker - Sanford Bernstein

If you could help dimensionalize that down 5% to 7% across the business segments a little bit more, give us a little more color for where you think that's going to be most likely, where you're expecting the worst and the least worst among those?

Patrick D. Campbell

The worst, I think, is going to be characterized in the industrial-related spaces. So our INTB business and probably our Electro Communications business probably will be the ones that are kind of above average, and probably D&G, I would say, or the optical business around electronics. So those would kind of be ones that I would say are probably the worst side.

Thank God we've got a Health Care business. You know, Health Care, I think, will perform not stellar, but it will be decent in these kind of markets. Consumer's a little bit of a wild card because Consumer's actually had kind of a tough '08, even though our market share in Consumer has done reasonably well. You know, the end market on a lot of the retail side has really been slow all year, so Consumer may be slightly better than the average. And then I'd say probably SSPS, our Safety and Security business, is probably more like the average, would be the way we're currently thinking.

So kind of the industrial side would be kind of below average.

Stephen Whittaker - Sanford Bernstein

You mentioned market share as being one of the possibilities; you expect some strength in that. Again, if you could just give us a perspective of what you mean by the strong survive in that case and are you talking price, are you talking terms, new products? What are the kinds of things that are going to help drive share in the next year?

Patrick D. Campbell

Well, I guess, a couple of things. One is we've got great brands. We've got very solid relationships with all of our customers. I think this is a situation where - and I can't tell you who, okay - but there's going to be competitors that fall out of the market. I think customers are going to want - and not that they're willing to pay, you know, whatever price - but there's a number of customers, I think, that are going to want to have that continuity of supply and the confidence that suppliers are going to be around.

Importantly, our mind-set, as George said, on the 98% - 95%, we're going to try to go after as much as share, but I think a part of that's going to be, I think, the result of some of our competitors possibly falling out of the market. So we want to be ready.

Scott David - Morgan Stanley

A couple questions. One, when you take a look at your guidance for next year, one thing that stands out a little bit is flat pricing. It seems a little aggressive given that it was tough to hold onto to pricing or tough to get pricing, I guess, in 2008. One would think, at least, that there's a chance that pricing could come down in 2009. Can you talk a little bit about past downturns what's happened to pricing and what gives you the confidence that you're not going to have to take prices down kind of in line with raw materials or even more so?

Patrick D. Campbell

Well, I guess, first of all, the reason we combine the two is because I think there is an interplay obviously between those two. If anything, my view is probably our material costs, we are probably a little too pessimistic on. So, as I put this together, I kind of looked at the combination of the two, to be honest with you.

It's our objective to try to hang on to as much price as possible. Now, I think we'd be foolish to stand here and say that we're not going to get a lot of pressure from customers. But you have to look at that between, obviously, the volume scenario that you're looking at, and we have to look at it very much on a market-by-market basis.

So on the one hand we want to try to maintain as much as possible, but we need to make sure that we're not losing share because of our price position. But I think on a net-net basis, I think we've got enough in I'll call it material side reductions to kind of keep that net number okay.

Scott David - Morgan Stanley

And just a quick follow up, if you will, to the gentleman's prior question. When you talk about the big inventory correction you saw in November and likely continuing into December, what segments particularly were hit the hardest?

Patrick D. Campbell

I would have a hard time saying there's not a segment. I have to tell you - and as George mentioned, of course - George and I spent part of our careers in kind of highly cyclical industries where these kind of changes aren't that unusual for a given segment or a given end market. But as we've done our research in the past and so forth, we can't find any time where there's been such a drastic change across as many markets and across geographies as we're currently seeing.

So I think we're seeing it, you know, especially on the distribution side and the OEM side. Both are significantly altering their - of course, on the OEM side, we're seeing it really through the production schedules and backing it through their plans, and on distribution, distribution is being very cautious on obviously what they're trying to stock as they go through the year.

So I'd say it was really across the board. I can't offhand think of any significant segment that wasn't impacted here.

George W. Buckley

I think in the past what we've seen is, you know, we've seen the U.S. market maybe going up, [general] market going down; general market going up, U.S. market going down. But what we saw this time is we've seen a synchronization of these markets unfolding in a way that we've just never seen before. I speculate that's - the banking crisis, which has done that, which is a very, very closely coupled marketplace. That spread fear; obviously spread issues of financing. They're the sort of things that force these markets to synchronize in this way in this near term.

We still believe - Pat and I are still very much committed to and still believe that, in the longer term, as these things sort of pass their way through the system and financing becomes available again, that we'll see the benefits of diversity coming back in again. But for now, right now, the synchronization seems even to have upended the theory that diversity is a good thing because they've just come together.

David Begleiter - Deutsche Bank

George, in the last downturn/recession, your volume fell faster than IPI. Given you now have a better R&D process, strong innovation, strong new product pipeline, why wouldn't your guide volumes decline at a lower rate than IPI this downturn?

George W. Buckley

I think we agree with you Dave. There may be a couple of different answers to this. One, that IPI is a broader representation of fast-moving and slow-moving businesses, so we may not be purely a good representation of IPI.

Another thing that sort of pops into your mind is that, because of the credit - I mentioned this just a minute ago, Dave - we think that's the reason why this thing has just sort of dropped like a stone.

But I think it's because the - the primary worry's basically the answer I just gave you, that we're probably not quite IPI; we're some kind of other custom market index, and that blend of long-term businesses, long-cycle businesses and short-cycle businesses, doesn't really properly affect us. Because it's not only, you know, when we talk about IPI, it's a number in stasis, it's a steady state number; they don't tell you about the dynamics of those markets as they move from one position to another. That's what we think is behind the change of this kind, Dave.

Patrick D. Campbell

And I'll give you the other practical planning side of it. I don't want to fool ourselves. I mean, obviously our objective is not to fall as much as our more negative IPI number. I think we'd be foolish to stand here, though, and say that we're going to outperform. From our side, we've got a plan for kind of a more traditional basis, kind of a worst-case view, and drive the organization to outperform this. So we're trying to make sure we've got a good foundation that we're working off of.

George W. Buckley

You would think, Dave, seriously, with all that we have done, unless we followed the wrong pathway, with all that we have done in reinvestments in the core, getting the supply chain licked into shape, localization, reinvesting in R&D, and even reinvesting in R&D in such a way that the quality of the R&D has gone up, in other words, more money in new products for new markets, you would think instinctively, intuitively, that that would produce kind of a better impact. There's no reason for us not to believe that is still the case, Dave, so we're expecting that in due course we will harvest what we've been reaping.

Jeffrey Sprague - Citigroup

First, just one for Pat and then George. Pat, as it relates to the charge - you're taking a large charge here to kind of jumpstart the cost reduction. Should we expect more of that, kind of the uncovered charge, in '09? Or if you go after additional productivity, would that be absorbed in the P&L?

Patrick D. Campbell

Well, you know, part of the reason - first of all, we try to call our restructuring, just to make it perfectly clear for people what's normal and usual, but also seem kind of planned to a steady state running the business. If it's a sizeable enough item, we will continue to call it out as a restructuring item.

Jeffrey Sprague - Citigroup

And then I guess just part and parcel to that question, planning for flat margins actually does not sound conservative. So it sounds like you're taking a conservative tact on revenues, but flat margins in this very uncertain environment actually feels a touch aggressive.

Patrick D. Campbell

Well, you can say it does. Now, of course, the reason for that is to drive our cost programs.

Now, if you look at our range of estimates, Jeff, you'll notice that down 3% to down 7% on the top line and then we've got down 3% to down 12%. I think if you get about halfway through the volume - say 5 - the margins, I think, we can kind of do that. Right now we haven't found enough just mathematically on how it'd probably hold margins at the lower end - or the higher end, I guess, from down 7% and down 12%, so we still have some more work to do there.

But I think establishing an objective like that to help gauge the activity that we need to drive inside the company is a solid thing for us to do.

Jeffrey Sprague - Citigroup

And then I just wanted to ask George, on the M&A front you guys have obviously been very active, but taking small steps, being careful, kind of just folding things in. Does that playbook change in this environment and what is your willingness to maybe go outside of the bounds of some of the core technologies that 3M's in today?

George W. Buckley

It's a good question, Jeff. I think that that piece of the puzzle remains in place, clearly. Those things can still come off and probably will be a feature of what we're doing. But there are going to be some acquisitions, I think, some opportunities that come up, as I mentioned in my remarks. They're going to come up quickly, so we've tried to prepare a thought list of where those activities are, the size of those companies.

And I do think that there's a possibility, although we're loathe to stray to far from our kind of core. It's just we think that's kind of a dangerous pathway to go down. But I think we're going to have to be prepared from time to time, Jeff, to consider those things when they come up because otherwise, I think, nothing's really changed. And we may end up taking more risk, I'm thinking, going down that pathway, but we may also have the chance to seal some deal that in all other circumstances was just not actionable.

So I think they have to go on the list for consideration, Jeff, but hopefully we'll use the same pathway. Pat and I are a bit conservative, as you well know, in these sorts of things. We're not going to be rushing to overpay. We're not going to be rushing into places that we don't understand very well. But here and there, where there are adjacencies, where we want to fill out the segment to really enhance our competitiveness, we are going to be prepared to do that.

Shannon O'Callaghan - Barclays Capital

So on plant capacity, right, I mean, you laid out in good detail here some of the aggressive headcount reductions. Where is capacity utilization now for the company and, if things play out as bad or worse than what you're thinking, what other actions might you have to take?

Patrick D. Campbell

Well, to be honest with you, we don't really have a consolidated utilization number. You'd be aggregating apples and oranges and grapefruit to kind of make that equation work.

It's fair to say that with volume coming down, some of the investments we've made, the actions we've taken here on facilities, don't take out the same capability that we're putting in. So if I kind of just do the math, our utilization rates are going to be down a little bit.

Now, to be fair, we've had some facilities that have been running seven days a week, so in some cases what we're looking at are bringing utilization rates down to a more normal work schedule as well.

But I don't think we're necessarily on a continuous basis reaching a point where we've got excess capacity and a utilization problem from a cost management standpoint. We will continue to work at rationalizing some plants. We'll continue to drive our supply chain strategy. Our supply chain strategy is as critical as ever, getting closer to customers, getting the right location, and then, especially with the dollar kind of moving the other way around, we've got to get some of our supply chains to move. So that' strategy is well intact, and we have to keep driving it.

Shannon O'Callaghan - Barclays Capital

There's no plans to significantly downsize the manufacturing footprint?

Patrick D. Campbell

No, you know, at this stage, I can't - and probably, to be fair, a lot of facilities that we're addressing here are smaller in nature. Some of it was some of our acquisitions that we made that were part of our plans anyways. So most of these are not large-scale plants, no.

Shannon O'Callaghan - Barclays Capital

Just one question on pricing. In terms of the flat pricing, what does that assume, D&G pricing is down next year?

Patrick D. Campbell

Well, I'm going to look to my friend. D&G pricing will be down next year. Offhand, I just don't recall the exact. So, D&G is probably down 3% or about 4%.

Clifford Ransom - Ransom Research

You've talked about stimulating your markets with innovation, but there's other ways to stimulate markets. Why aren't you talking more about levers like marketing and sales and advertising or is it just there's no point in shooting off your gun if there's nobody to listen?

Patrick D. Campbell

First of all, sales and marketing, I guess, Cliff, maybe I did a poor job of explaining it because that's kind of the day-to-day job of people.

Part of the issue on advertising, though, is, especially in the consumer space, we have to make sure that there's - first of all, we have to make sure we've got coordinated programs with the retailers and prioritize those with them and continue to drive exposure and advertising programs with them. But at the end of the day, you also have to make sure that you're really going to get more volume out of it.

As a matter of fact, in our plan - and I didn't really show it this way - within Consumer, as an example, we actually would be increasing their advertising dollars, actually in a slower market, to try to get at it.

Clifford Ransom - Ransom Research


Patrick D. Campbell

Okay, I'll answer that, and then George, do you want to come back on the other side?

George W. Buckley


Patrick D. Campbell

We've had a very active program, Cliff - I think you and I've talked about this - over many, many years. And as George said, there's two ways, you know, when you run a company to manage cost. On the upside, when volume improves, the best thing to do is have the discipline of not putting cost into the system that you have to take out later.

Even though we think our restructuring numbers are relatively large, in some context you may kind of view them as being relatively small as a percent to total employees. Part of that's because we've been very cautious on adding people back in as the businesses improve. Now, if you've seen our margin improvement over the years, a lot of that is through G&A leverage because our volume is ramped up. Effectively, we haven't been putting cost back in the system. As a matter of fact, our G&A cost is actually down from probably the early parts of 2000 on an absolute basis, probably by a couple hundred million dollars.

So we continue to work that program because it's our belief, you know, how you drive more value is putting the dollars at the customer-facing side of the business, not in the transaction side. So we continue to push the lever on that one.

George W. Buckley

I think, Cliff, we will - in fact, when I made my remarks I mentioned the temptation was to cut R&D, I did mention also advertising and merchandising. While I went on, then, to describe more about innovation, I was just basically trying to make the point that the old stuff still works in 3M, that differentiation does still work.

You should not, then, read into that that I meant to exclude, in some way, advertising and merchandising. In fact, we have a whole group of our colleagues would like us to really wind that up. I think it can have short-term benefits, but I still think that always a balanced blend of the advertising and merchandising and R&D spend is the right approach.

John Roberts - Buckingham Research

Your emerging market exposure percent of sales has been going up about 2 percentage points a year. It's up to 30% now. Does it accelerate in the next couple of years? Do you think you get to 35% or higher by 2010, and does this restructuring shift your costs that way, too? Are you going to shift approximately 5 percentage points maybe of your cost base into other markets, away from U.S. and Europe.

Patrick D. Campbell

Well, first of all, we wouldn't be shifting 5 points, just because of the installed base we have, John. But we will be investing in those emerging markets. Is it 35? Actually, if the developed markets remain sluggish here for awhile, the emerging markets could end up probably pretty close to that, yes. I haven't done the math, but probably that's not too bad a number.

Martin Sankey - Neuberger Berman

On the balance sheet, your company's in excellent shape both in capital structure and term structure. As you adjust the system to a lower activity level, I presume inventories will shrink and you'll be generating a fair amount of cash. What do you see as the precursors to resume share buyback activity, assuming no large acquisitions?

Patrick D. Campbell

Well, first of all, I guess your premise is, you know, hold; that obviously as volume shrinks, we are a working capital user with volume. So as volume comes down, working capital should free up. You'll probably see probably a bigger impact probably on the AR side than you will the inventory side.

When it comes to a repurchase, I guess my view would be that we have to have pretty clear signs that the economy is coming back in kind of a sustainable fashion before, at least from my perspective, I'd probably alter our thinking on repurchase activity.

One additional area that will become a funding need for us will be the pension plan. I didn't spend a lot of time talking about it. I talked about kind of the P&L side. There will be a funding requirement over time that we'll have to look at depending upon where market asset rates and the liabilities go over time. But anybody who has a DB effectively has kind of the same issue. Over the next many years, we're going to have to put some money back into our pension plan.

So as we kind of finalize our thinking around that after we see our final results for the year and we look at what we want to do on dividends and so forth, a repurchase would probably be kind of the middle of the bottom of that part of it.

Charles Harris - Ridgecrest Partners

Going back to one of the first things, George, that you said, which is it's sort of an unprecedented coordinated global drawdown in your end markets, if we use the word unprecedented and suggests that it's different this time in some way, shape or form, the restructuring program that you've laid out and the cost reductions are sort of paste and measured as if, you know, it's a recession, we know how to deal with these things. What if that second quarter doesn't start to show us the stabilization in Q3 that you're looking for? Can you flesh out a little bit of what might be called Plan B here?

George W. Buckley

Well, I think Plan B turns out to be a continuation of Plan A. It depends on which markets are down, where they are geographically, but I think it means continued attack on costs and that generally means people. But there are also a lot of things we can do as well. There's no reason to believe that, if things got into some sort of real Doomsday scenario that we wouldn't continue to shrink, both in manpower, both in plants, in concert with whatever the end markets turn out to be.

Clearly, the danger for any company in these sorts of circumstances, you get - I mean, we all use these figurative descriptions, but it's one thing cutting the fat; we're going to get soon to a point, if we're at that point that you're just suggesting, we're going to be cutting muscle and bone. So there may be some things, candidly speaking, we just decide to stop doing, markets we get out of just because they're not economically viable.

But I'm not ready to accept that we're at Armageddon yet. But we are and we have this. This is what we've shown that we are disposed to do. Pat and I've been very much on top of this stuff  even ahead of this stuff  so if more is needed, then more will be done. Simple as that.

Patrick D. Campbell

It's fair to say that there are other alternatives that are being worked on that may not have the same kind of return characteristics that we have in this restructuring plan. And as an example, I mentioned that we got kind of a one-year payback. We know that we could actually probably reduce the work force by some more if we were willing to pay a lot higher price to do it. Thus far we don't think we're at that point.

So we continue to look for alternatives - and, of course, we're trying to prioritize which one's giving the best payback. And then as things really get worse or continue to get worse than we think, you may have to kind of reach a little bit deeper. But we're not there yet.

Melissa Cook - CLSA

I have a question about Asia and China, more specifically. I know we're really in uncharted territory here as far as forecasting this world economy, but in China it's even more difficult. And I wonder if you could share with us some of the metrics you're using to look at the Chinese economy. Are you expecting any benefit from the government stimulus?

And then on the flip side, what kind of investments would you look at to position the company for a bigger share in China in the recovery?

George W. Buckley

We already advanced about a year ago our investments in China. Just to sort of give you a perspective, GDP last year was, what, 9% or so in China, I think. The forecast is around 7%. Now, whether it turns out to be 7% or some other number remains yet to be seen.

Our business in China has been growing in the 20s, so we've been already growing at somewhere around three times GDP. And in fact in recent times when we've invested more, we've accelerated that yet further still. So I think there's still huge opportunities in China. Nobody really knows at this moment in time, as you rightly pointed out, whether that 9% will become 7% or that 9% will become 5%, that 9% will become 3%. Nobody really knows.

And there are some peculiarities of the Chinese psyche and the Japanese psyche and the Korean psyche. They save an awful lot of money. So I think it remains yet to be seen whether the Chinese consumer actually pulls the Chinese economy up back to sensible number.

The Chinese government, as you know, is proposing - I've heard different numbers - $550 billion of investment in that economy to try to drive jobs. You have to believe, unless there's some sort of window dressing on that, that it's actually real, new money, that that will have some impact.

But for us, we remain at this juncture very positive about China. We see lots of opportunities in automotive aftermarket, which are really doing very, very well for us right now. So until times prove to be different, we intend to continue with our accelerated investments in China, probably also Latin America. And I mentioned two others when I spoke about the solar opportunities here in the U.S. and also about water infrastructure. And I'm not talking about the classic stuff that you see on water. I'm talking about the underground pipe work, which is in really terrible shape.

So we've got good opportunities, I think, for investment and great growth programs here. Of course, we hope that they will help mitigate some of these downsides. We are focusing a lot more in the U.S., trying to align our resources with the markets. Like any company that's been in a market like this for many, many years, the market drifted away a little bit from our resource focus. We're trying to realign that so we can get some extra growth there. And, of course, Japan is the other one that fits into that same category - big market, still got currency going for it, and if we pull that off, then I think a combination of those things could help mitigate some of the numbers that Pat has laid out.

But for now, that's where we're planning. We think this going to be down 7%. And I think we can drag it up somewhat [inaudible], but there are some of the things that we're thinking about doing - not thinking, actually doing now.

Patrick D. Campbell

You know, even though, as George mentioned, our performance growth rate has outperformed the economy, I think we would all admit that probably we'd like to be a lot bigger in China than we already are. And it's kind of been our own strategy around hiring the right people, developing them, retaining them that kind of somewhat limited our own growth rate in China.

So hiring people in China, a lot of the investments that we're currently looking at to grow China is all about feet on the street, getting more and more people in. So it's not a heavy investment and it's a relatively low risk approach to try to take on and grow.

George W. Buckley

So it's not big capital assets, for example.

John Flannery - Portland House Advisors

I guess my question is: How has the discretionary nature of your dental business figured into your outlook for the overall Health Care segment?

Patrick D. Campbell

Well, obviously, you've got some insight, knowing there is a discretionary side of the dental market, which there is. There's an element that does flow, as people kind of make a trade-off as to either on the dental side or the orthodontics side of actually starting for - I'll call it discretionary dental work.

But within kind of the guidance that I gave your for Health Care, that includes kind of a flattish type dental market. I think we'll continue to make good inroads from a share standpoint, but not looking for an overly aggressive dental market growth during these kind of times.

George W. Buckley

You know, we have a pretty good worldwide Health Care, including dental, business. And I think it's true to say the way that we manage our health care in the United States, there are some elements of that Health Care business that are more discretionary. But then they would be, say, for example, in other countries that have nationalized or government-provided health care. You're really dealing with the base level cases that have to be dealt with.

So it's my view that's what's like to happen is we'll still see relative stability in those overseas markets - the U.K., Germany, Canada, Japan, where most of the health care is provided by the government, and it's at a much lower level than we're accustomed to in this country. So I think we're going to see that kind of discretionary swing more in the United States than we would in other countries.

That does tend to mitigate some of the things which you might fear most in health care because we do have this great global presence, and the U.S. is sort of a bit of an aberrant piece of the puzzle here on health care.

John McNulty - Credit Suisse

Just a quick question on working capital, in particular on the inventory front. You'd indicated earlier your customers with the destocking will take about three to four months to get through it, and then later on you had talked about how, because of your FIFO inventory accounting, we won't see much of a decline in your raw material expensing until the second half of next year. So it sounds like you've got some pretty fat inventories relative to, say, your customer levels. Can you kind of clarify that for us and maybe give us a little color as to what you can do to maybe thin those down a little bit or what actions you may be taking on that?

Patrick D. Campbell

Well, John, there's not many ways to thin it down other than to make things.

George W. Buckley

Make it and sell it.

Patrick D. Campbell

So it's going to depend upon the customer schedule at the end of the day. The point I was trying to make was - two things. One is you've got a contraction or a customer base going on here in November/December. We still have a - normally, I'll call it our higher-cost inventory would have then been rolling through the system here between Q4 and Q1, before we'd start to, I think, start to see some reduction. But with the schedule cuts, it probably may take us awhile - Q1, Q2 - before that layer kind of works its way through the system.

The only way to solve it effectively is you're going to have to make it and sell it. That obviously will depend upon customer orders.

We try to be probably a little on the conservative side to make sure that we don't kind of build in an unreasonable cost reduction here that may not materialize until later in the year.

Bruce Babcock - Saybrook Capital

In your economic planning, are you giving any consideration to the idea that the consumer, who hasn't been doing any saving in quite awhile, may increase his savings, say, the next few years, with a really sort of negative impact on consumer spending and the economy in general?

Patrick D. Campbell

Well, I wish I could say all the elements of this forecast is that precise, okay? We try to bracket it. You looked at both of what the economists have for the IPI forecast [inaudible] GDP as well. What we tried to do is we tried to take theirs and basically take kind of a downside view. So on the one hand I could say that reflected in that lower level of economic activity is a kind of a slower consumer side.

We're definitely seeing on, say, the consumer electronics side that the consumer is adjusting here in the fourth quarter. You can see in auto sales that those are down. So there's a lot of things in the consumer area that definitely have had an impact, not necessarily because of the savings rates necessarily going up yet. So I think we're covered within '09 with that volume forecast.

George W. Buckley

And I think there's a possibility that some things have changed on this occasion, on this particular cycle. You know, classically what happens is consumer confidence improves before the economy and helps to drive the economy out. I think it may well be that the reverse is true here, that we've had so much bad news, the consumer's been so battered that what's actually going to have to happen first is the economy is going to have to improve before confidence improves.

It sort of speaks to your point that there may be another sort of sting in the tail here if consumers change their behavior. On the other hand, we all tend to be creatures of habit. Once the external pressure lapses, we tend to go back to the kind of behaviors we always had.

But nevertheless, I think it's a good point that you make, that there could be just that little additional sting in the tail that might provide a lag in recovery, maybe over and above what we might expect. So it's a good point you make, I think.

Patrick D. Campbell

Yes, especially here in the U.S., where it's such a large percent of the market, of the GDP, consumer spending led.

John Roberts - Buckingham Research

George, in your opening remarks I think you specifically called out water infrastructure and solar infrastructure in the U.S. as being a kind of bright area for next year. Could you maybe elaborate a little bit more? I think you talked a little bit about underground pipes. It's not Kuno, then, that you were referring to on the water side?

George W. Buckley

No. On the solar, that's pretty straightforward. It's basically organizing ourselves to sell into these markets. I think you know that we've created a division. We are repurposing some capacity that was formerly for optical films to make for solar films, which is obviously very good. We're getting a lot of traction. We got one very large order from a customer just recently. We need to make one small breakthrough. There is a small breakthrough on technology to make sure that order becomes viable. So that really does seem to be getting traction, and I think as we add more people to that, that really does offer a lot of upside to us.

On the water infrastructure, when we bought this company in the U.K. called E. Woods. They had a technology for coating the inside of pipes. And I don't think you've seen this sort of stuff, but a lot of the water infrastructure in the sort of modern, Western nations - the U.S., France, the U.K., Germany - often have their main water pipes down to maybe 20% of the cross-section available for carrying water, all plugged up with salts and crud, corrosion.

We have a system which will draw that out, recoat the pipes. And you can do it in situ, so the roads don't have to be dug up. You make a kind of penetration roughly 1,000 meters apart, and you can do that in situ and provide huge extra capacity and, by the way, stop the leakage. I don't know if you know in a cities like Paris, France, and London, about 50% of the water pumped into the system is lost through leakage. So the shortages of water that we experience can be solved, at least in part, by these kind of technologies.

So we probably see that particular technology as probably the largest single growth opportunity that we have in the company, even above solar. So we are on the lookout. We have the materials; we're on the outlook for a - we're going to experiment with some of the service companies. We probably will then buy a small one and work with the engineering companies - maybe even buy one of those - that makes the equipment, and see whether we can turn this into a real growth engine above and beyond anything that [Q] now would do.

So it looks like there's going to be some real good opportunities in that area and we're in the process right now of organizing to get it done.

Craig Evander - PCM

Can you give a little bit more color on the emerging market sales? How much of the sales do you think are used for internal consumption versus reexportation to developed markets and how that mix might be today versus what it was in 2001?

Patrick D. Campbell

Well, that's a little hard to say, but if you take China, as an example, our strategy in China is heavily China for China. We're not exporting. Now, of course, material that we supply other manufacturers in China, their products, of course, could be exported back out. But in most cases in the emerging markets, our direct volume is very much for the local market.

And I don't know if you're trying to get at the issue of how connected the world is relative to kind of volume and so forth. The reality is the world is connected so, when you get a slowdown in one part of the world, it's going to affect, obviously, some of the emerging markets, which basically has, in many cases, been set up as being a manufacturing base for supplying the developed market. So there's no doubt that there's going to be a slowdown there.

We do think that there's still going to be good growth potential for those markets, but to give you an exact number, offhand I don't think I know on an emerging market basis what the reexport piece of it would be coming from the customers that we're selling to.

John Roberts - Buckingham Research

I assume optical films is having a double dip, but I just wanted to check that assumption since it dipped well before the overall market and everything; it was in restructuring already. Was it down low enough that perhaps it didn't go down a lot more? The lows that you've had in earnings from restructuring in the optical films area.

Patrick D. Campbell

Are you talking about kind of fourth quarter, John?

John Roberts - Buckingham Research

Or current. Whether it's fourth quarter, first quarter, but is it going to bottom lower than where it was?

Patrick D. Campbell

I think what's fair to say is our market share in that business has stabilized, but I think it's also fair to say that the demand in those markets is also going through an adjustment period here in November and December. So you will actually see to some degree a more accelerated fall off here in the fourth quarter as that whole industry goes through a correction period as well.

But it's not because of our market share, John. It's really because of the end markets adjusting faster.

George W. Buckley

In fact, what Mike Kelly has reported to me is the good news that attachment rates are now building again.

Now, you shouldn't imagine that means they're building from 12% to 60%, but they are building again. We're winning back share, and it's primary off the energy activities now, converting screens like the one that we see down in front of the room here, taking out 50% of the lamps and therefore being able to eliminate roughly 50% of the energy. That is now happening. It's gathering real momentum, both in flat panel televisions and in monitors and notebooks. That's really getting a lot of traction. And we have a great proposition for that with our deep bath films.

So we seem to be - I don't want to declare victory on that - but it seems to be that we're not beginning to make some good progress there. But nevertheless, as Pat said, I think it gets offset by the overall market decline. It's not that there's a new problem in that area, it's just that it's reflecting what's happening with end market demand.

Eliott Fructer - Galeon

Can you talk about the segment margins in the fourth quarter versus your expectations kind of in the way you talked about organic growth? And if you will also on where the restructuring items fell.

Patrick D. Campbell

Well, first of all, restructuring is going to cut across all businesses. There's no business that was immune from kind of a reduction in the quarter - and all geographies as well.

I guess it's an interesting question as to what the expectation was for fourth quarter. You're going to see margins in the fourth quarter are going to be down in all segments. Every business we have, every geography we have in November-December, it's volume is quite a bit below what our expectation was and what our run rate's been, so you're going to find the margins are going to proportionately go down for all the businesses.

George W. Buckley

But to be fair to us, we were well aware of the cost curve, so we'll see that kind of pressure just a more factory pressure than we will in SG&A pressure. That will help lift us. But Pat is absolutely right. We expect to see some kind of declines in margins overall, but probably it's going to be factory led just on the volume issues.

George W. Buckley

Thank you very much, everyone, for your questions and for your attentive time. Appreciate it. Thank you.




Source: 3M Company Financial Guidance Call Transcript
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