Q1 2013 Earnings Call Transcript
Transcript Call Date 04/25/2013

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the 3M's First Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we'll conduct a question-and-answer session. It is recommended that you use a landline phone if you're going to register for a question. As a reminder, this conference is being recorded; Thursday, April 25, 2013.

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

Matt Ginter - VP, IR: Thank you and good morning, everybody. I am here with Inge Thulin today 3M's President and Chief Executive Officer and David Meline, 3M's Chief Financial Official Officer and thanks for joining our first quarter business review.

Note that today's earnings release and slide presentation accompanying the call are posted on our Investor Relations website at 3M.com, under the heading Quarter Earnings. Also note that our next two earnings conference calls are set for July 25th and October 24th. In addition, we will host Investor Meeting on the afternoon of Tuesday, December 17th at the Grand Hyatt Hotel in Midtown Manhattan. For now lock-off 1 to 5 pm on that day, if you would.

If you please turn to Slide number 2. During today's conference call, we will make certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions.

So, now I will turn the call over to Inge and please turn to Slide number 3.

Inge G. Thulin - Chairman, President and CEO: Thank you, Matt and good morning, everyone. I appreciate you joining us this morning. Overall this was a good quarter for 3M. We delivered solid results in the phase of a stronger U.S. dollar and lower factory utilization in few businesses. Double digit organic growth in China, Latin America and Middle East Africa helped us overcome weakness in Western Europe and Japan.

I am pleased that we posted sales growth of around 2% against the backdrop of 0.8% worldwide IPI. Four of our five business groups achieved positive organic sales growth in the quarter. Health Care posted a 4% gain in organic local currency as did consumer coming off a very strong Q4. This is the first quarter of reporting based on our new structure, and as a result we have clearer visibility on all of our business groups.

Let me make a comment on importance of this change to the electronics and energy business group. Here, the new structure not only give us better visibility, but also set the stage for better asset utilization in the future. We are seeing early progress today and I know that we will see even more as this team takes shape.

On the customer front, electronics and energy, energy creates for us a launching pad from which we can quickly introduce a broader range of technologies into the market and fully capitalize on the outstanding customer relationships 3M has earned in this space. In other words, it creates opportunity. So, Q1 give us many things to be happy about.

That said, I want to be clear that we view this quarter in a much longer and much larger context. We will continue to manage 3M for the long-term and for the sustained success of the Company. That approach is clear when you look at our ongoing investments to improve the business. For example, as we told you last November, we are increasing our investments in research and development, and intend to be closer to 6% of sales at the end of the five-year planning period. We continue with capital investments to improve productivity and grow the business. We remain on track for CapEx investments of $1.6 billion to $1.8 billion this year. We are building new strength in emerging markets. In a number of push forward businesses like Health Care, we are adding resources and on-the-ground expertise. In summary, we are moving forward on all fronts.

We will be pushing hard to take advantage of any recovery in the second half. Note, that we have not adjusted our expectation on the organic local currency growth, which remains at the 2% to 5% for the year. We remain focused on driving growth everywhere.

Now, let me take you through a quick look at Q1 results. EPS was $1.61, up slightly year-over-year. Operating margins were 21.6% on GAAP basis, basically flat year-on-year and up sequentially, consistent with historical patterns. Four of our five business groups came in above 21%. Excluding the effect of acquisitions margins were 22%, very strong. Sales were $7.6 billion, up 2% in dollar terms and a record first quarter for us.

Organic local currency growth was up 2.1%, with Health Care and Consumer up 4%, Industrial up 3% and Safety and Graphics up 2%. Geographically, Latin America Canada was up 7%, the United States and Asia Pacific were up 2%, and Europe, Middle East, Africa, down 1%, with Western Europe the main area of challenge. Currency had a negative effect on sales of almost 2% in the quarter and acquisitions added about the same amount.

Finally, in the quarter, we returned $1.25 billion of cash to shareholders via dividends and share repurchases. The first quarter validated our previous view about the beginning of this year. As you recall, we anticipated continued uncertainty and slow growth in the first half of the year, especially in the electronic space, and that is exactly what we saw. Today, as we look back at Q1 and forward through the rest of the year, we see reason to adjust our guidance in the interest of credibility and clarity.

Two primary factors are driving this decision; first, macroeconomics. The economy remains uncertain and external forecast have declined a bit since the year end; the developed economies in Western Europe and Japan, in particular. On a market level, consumer electronics continue to present challenges. While there are some indications of an upturn later in the year, (optimist) is tempered by the current reality. We expected a challenging start to the year, but in fact market conditions were tougher than we had expected.

Second, the stronger U.S. dollar. We previously anticipated that 2013 currency effects will be neutral to sales and earnings. We now expect 1.5% sales headwind and a $0.05 per share earnings impact for the year. The recognition of these realities leads us to an EPS outlook for the year of $6.60 to $6.85 per share. In the quarter, we announced 3M's 55th annual dividend increase, an increase of 8%. In addition, we announced the new share repurchase authorization of $7.5 billion.

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

David W. Meline - SVP and CFO: Thank you, Inge. Let's begin with Slide 6 where I will breakdown the first quarter change in sales. Organic local currency growth was 2.1% against a challenging economic backdrop as Inge mentioned. In fact, the most recent forecast from Global Insight calls for a 0.8% worldwide IPI growth in Q1. Volumes contributed 1.7% for growth and selling prices increased 0.4%. Acquisitions added 1.7 points to sales growth in the quarter. Three deals contributed to this growth, Ceradyne in our Industrial business, FSTech in Safety and Graphics and CodeRyte in Health Care.

Foreign exchange impacts reduced sales by 1.8 percentage points in the quarter due in large part to a 14% devaluation of the Japanese yen versus the U.S. dollar. In dollar terms, worldwide sales grew 2% versus the first quarter of 2012. On a geographic basis, Latin America, Canada led the way again this quarter with organic local currency growth of 7.3% and all five of our businesses posted positive growth in that region. In particular, Health Care and Safety and Graphics grew double digits.

In the United States, organic local currency growth was 2.3% led by a 5% increase in the Consumer business. We also generated positive growth in Industrial, Safety and Graphics and Health Care. Asia Pacific grew nearly 2% organically in the first quarter. China, Hong Kong grew by 10% in Q1 and Japan declined by 8%. In EMEA or the combined Europe, Middle East and Africa, first quarter sales declined 0.8% on an organic local currency basis. Health Care generated low single-digit organic growth in EMEA. Industrial was flat and the three other businesses declined year-on-year. On a regional basis, we achieved solid organic growth in both Central East Europe and Middle East Africa and Western Europe declined 3%.

Let's move to the income statement. Please turn to Slide 7. First quarter sales were $7.6 billion, up 2% in dollar terms. Our gross profit percentage was a strong 48%, equal to last year's comparable quarter. SG&A spending rose in line with sales and we increased R&D investments by 5% year-on-year to $430 million. Operating income increased nearly 1% to $1.6 billion. GAAP operating margins were 21.6%, down 20 basis points year-on-year. Included in these results was a 40 basis point headwind from acquisitions, therefore underlying margins increased 20 basis points in Q1 to a solid 22%. Profit leverage on organic volume growth added 20 basis points to first quarter operating margin and lower year-on-year pension and OPEB expense added another 60 basis points. The combination of lower raw material costs and higher selling prices added 90 basis points to first quarter margins.

Lower factory utilization reduced margins by 1 percentage point, largely related to excess inventories in pockets of our Electronics and Energy and Industrial businesses. First quarter earnings were $1.61 per share, up 1.3% versus the first quarter of 2012. One more item which is not on the chart relates to our corporate and unallocated segment. You will see a first quarter expense in corporate and unallocated of $74 million, which is a $64 million improvement year-on-year. Pension and OPEB expense declined which accounts for one half of that improvement. Part of the remainder relates to our ERP project. Now that we are moving from the development stage into deployment, more costs are being (borned) by the businesses rather than corporate. On average, this reduced operating margins in each of our businesses by approximately 30 basis points in Q1 with the benefit coming in corporate. We expect this 30 basis point margin impact to each of the businesses to continue throughout 2013.

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

Now, let's turn the cash flow. Turn to the Slide number 8. First quarter operating cash flow rose by $166 million or 20% to nearly $1 billion. Cash flow benefited from $269 million of lower pension and OPEB contributions offset in part by higher tax payments. We invested $324 million in capital expenditures during the first quarter, up $63 million versus first quarter of last year and are projecting $1.6 billion to $1.8 billion for the full year 2013.

Free cash flow rose by a $103 million or 18% to $670 million. Free cash flow conversion was 59% and 9 point improvement versus the first quarter of 2012. First quarter is typically our seasonal low point for free cash flow conversion and improves as the year progresses. We returned $1.25 billion to shareholders in the first quarter comprised of $440 million in cash dividends and $805 million of gross stock repurchases. For the full year, we are now tracking towards $3 billion in gross share repurchases, which is at the high-end of our previously expected range of $2 billion to $3 billion.

Let's review in more depth our first quarter performance on a business-by-business basis, starting with Industrial. Please go to Slide 9. First quarter sales were $2.7 billion in Industrial, up 3% on an organic local currency basis, against a tough 7% comp in Q1 of 2012. Most of Industrial's businesses grew organically in the first quarter. Aerospace again grew double-digits due to a combination of market share gains and strong end-market growth. Industrial, adhesives and tapes, which is 3M's largest operating division had solid organic growth in the quarter as did the personal care business.

Organic sales declined in our advanced materials business. Automotive OEM grew 2% organically in the first quarter versus a 1.5% estimated decline in Q1 global auto production. We continue to gain relevance and higher penetration levels in this massive market.

On a geographic basis, organic local currency sales in the Industrial business rose 6% in Latin America Canada and 4% in both APAC and in the United States. Organic sales were flat in EMEA with broad-based declines in Western Europe, offset by double-digit increases in Central Eastern Europe and in Middle East Africa. The Ceradyne acquisition added 3.6% to this quarter's growth in Industrial. Integration is progressing very well with newly combined technical teams working to identify a number of future growth opportunities. We are injecting Lean throughout the operation to drive maximum efficiency and capture value quickly. Profits are ahead of plan, while sales were short of plan in the first quarter, largely defense-related, whereas sales in the industrial parts of the business are on track. We were encouraged in March when Ceradyne was awarded a $40 million plus order from the U.S. government for Small Arms Protective Insert armor plates for the government of Afghanistan. First quarter operating income was $576 million and reported margins were 21.5%. Ex-acquisitions, Industrial operating margins were 22.5%.

Now, let's move to Safety and Graphics. Turn to Slide 10. First quarter sales were $1.4 billion, up 2.3% on an organic local currency basis. This growth was led by our commercial graphics and architectural markets businesses. We also posted positive organic growth in building and commercial services, personal safety products, and roofing granules. The traffic safety and security systems business posted an organic sales decline in the first quarter, largely due to weak government funding levels and a slow start to the U.S. construction season.

We also restructured part of the business in Q1 to improve its competitiveness going forward with associated cost of $4.5 million in the quarter. On a geographic basis, organic local currency sales rose 10% in Latin America/Canada; 4% in Asia-Pacific and 3% in the United States. Organic sales declined 4% in EMEA.

The FSTech acquisition added 2.2% to growth in the quarter and integration efforts are tracking well versus our expectations. This business also secured a major contract during the quarter for highway tolling with the Bay Area Transportation Authority in San Francisco. Operating income in Safety and Graphics increased slightly to $335 million and operating margins were strong 23.7%. Excluding acquisitions, first quarter operating margins increased 20 basis points to 24.3%.

Next up is Health Care found on Slide 11. Health Care sales totaled $1.3 billion, up 4% on an organic local currency basis. We grew organically across the Health Care portfolio with particular strength in food safety, critical and chronic care, and health information systems. On a geographic basis, Latin America/Canada grew 12%, Asia Pacific grew 7%, EMEA grew 3% and the U.S grew by 2%.

In developing markets, Health Care grew 13% on an organic local currency basis with notable strength in India, Middle East, Africa, Brazil, Central East Europe and Southeast Asia. Developing markets represent one-fourth of our Health Care sales today and a significant opportunity for tomorrow. In developed markets, the business grew 2% organically, including 6% in Japan.

Operating income rose 1% to $404 million and margins were 30.8%, down 60 basis points year-on-year. Starting January 1 of this year, we began absorbing additional costs related to the U.S. medical device tax. The first quarter cost was just over $5 million representing a 40 basis point drag on Q1 worldwide operating margins. For many years, our Health Care business has grown organically each and every quarter with consistently outstanding margins. The business generates tremendous value for our customers and for shareholders.

Please turn to Slide number 12. In electronics and energy, sales were $1.3 billion for the quarter, down 2% in organic local currency terms. Growth was slightly positive on the energy side of the business with strength in electrical markets offset in part by weakness in telecom and renewable energy. Electronics, which is 60% of the segment, declined about 4% organically. Lower market demand also triggered sizable inventory reductions by some of our OEM customers and their tier suppliers. As a result, our factory utilization ran lower than we have been expecting and we expect this will persist into the second quarter.

From an electronics end markets standpoint, we are expecting a second half recovery for three primary reasons. One, inventory should be in good shape after Q2, two, wafer starts and capacity utilization are gradually increasing, and three, the semiconductor book-to-bill is indicating an upward trend.

Operating income in Electronics and Energy declined 16% year-on-year to $296 million and margins declined 2.4 percentage points to 15.3%. Lower volumes and utilization were the primary drivers here.

Finally, let's review the Consumer business, found on Slide 13. Sales in Consumer were $1.1 billion this quarter, up 4% on an organic local currency basis. All of our businesses delivered positive local currency organic growth this quarter, with particular strength in the Consumer health care, DIY and home care businesses.

From a geographic perspective, organic sales growth was 8% in Asia Pacific and 5% in the U.S. and in Latin America/Canada. EMEA declined 6%. In developing markets, the Consumer business grew 9% in organic local currency in Q1. Consumer is one of our most significant opportunities in developing markets as the middle class is growing rapidly in many of these countries and retail is growing with it. 3M's global capability and local presence around the world gives us a distinct advantage in serving those retail customers. Quarterly operating income was $237 million in Consumer, equal to the first quarter of 2012 and margins were 21.9% for the quarter. Margins declined 40 basis points year-on-year due to higher investments in areas such as e-commerce, design and advertising and merchandising. So that concludes our review of the first quarter, now I will turn the call back over to Inge.

Inge G. Thulin - Chairman, President and CEO: Thank you, David. Before we go to your questions, I wanted to update you on our progress in several areas. First, portfolio management; on the Q4 call I referred to actions to consolidate our Traffic Safety Systems and Security Systems businesses. These restructuring actions were completed in the quarter with associated cost of $4.5 million in the quarter. The point here, of course, is that we are directly addressing the more challenging segments of our portfolio. You should also know that we are increasingly directing a larger percentage of resources towards (indiscernible) and push forward businesses. Second, a word on Ceradyne; as David mentioned, the integration of Ceradyne is progressing very well and profits are ahead of plan. I'm excited about the emerging technology synergies from our newly strengthened ceramics platform.

Finally, we announced new leadership in APAC region. Our new area Vice President of Asia Pacific, Jim Beaumont has successfully managed a wide range of businesses and functions across the Company and has extensive international experience. He is a proven leader. In addition, Kenneth Yu, the energetic long-time Head of 3M China will now be applying his impressive business building skills in developing markets around the world. The new leader for 3M China is Donald Chang, who most recently led and developed our business in Southeast Asia very successfully. Donald is another great builder of businesses and the ideal new leader to implement our new China plan. So, history, a very strong leadership in APAC region continues.

To wrap up, we remain confident looking ahead and are keenly focused on elements within our control; advancing our long-term strategic objectives, driving productivity and improving the business. 3M's unique combination of technology strengths, manufacturing excellence and global capability will enable us to deliver sustainable increases in sales, earnings and cash flow. As I said earlier, we are moving forward on all fronts.

Thank you. We will now address your questions.

Transcript Call Date 04/25/2013

Operator: Steven Winoker, Sanford Bernstein.

Steven Winoker - Sanford Bernstein: Just so I understand, how are you thinking about the cadence of, I guess, what's implied 2% to 6% top line growth for the rest of the year. You've mentioned a lot of different dynamics going into that, but if you sort of take us through the quarters and how you are thinking about that or just as maybe how you are thinking about that ramping up, that would be helpful?

David W. Meline - SVP and CFO: So, if you look at how we think the quarters are going to develop, Steve, we think that it's really looking to us more like a first step, second half story right now. So we think that the second quarter specifically in the Energy and Electronics is going to run in a similar fashion to what we saw in the first quarter, followed by an improvement in that segment in the second half. Then likewise, if you look at the other businesses we are observing that we will expect to see some level of improvement in second half.

Steven Winoker - Sanford Bernstein: Then could you also maybe just go through a little bit more of expectations or what you're seeing in China in terms of stocking levels and liquidity across the different businesses?

David W. Meline - SVP and CFO: Yeah, so if you look at China, first of all, I've observed that we saw a 10% organic local currency growth again here in the first quarter. If you take that and separate Electronics and the balance of the business we ran at 8%. So if you think of base business at 8% in China versus it was at 10% in the fourth quarter of last year. So, pretty steady. Then you saw a decline in the Electronics and in this case Energy segment, including renewable, that caused the total growth in China to go from 16% to 10%. So we're seeing part of the Electronics issues that I referred to and Energy are based in China as they have a big renewables business there. So, we saw decline in that area, which we expect will continue into the second quarter, whereas in the base businesses, Industrial, for example, and Safety and Graphics ran at 10% and 11%, respectively, which is very consistent with what we saw as we finished the year last year.

Inge G. Thulin - Chairman, President and CEO: Steve, this is Inge. I think on the growth piece, the way I think about it is this is the second quarter now when we have showed growth, and the 2% growth in this quarter based on the IPI growth we feel okay with. Now, that is one of reason. You said 2% to 6%, we are saying 2% to 5% in the growth range for the year; so not 2% to 6%, 2% to 5%. We don't change that because we are coming off of a growth quarter of 2%. Second quarter, as David said, look very much like the first quarter. Relative to China, it's good to see we had growth in Q4, we had 10% growth in Q1 coming out of three quarters earlier or basically no growth. Now, we believe still is fragile in China when you look upon external data, and in Q2 it could sidetrack based on growth, right. So, we are optimistic, but we still need to see more evidence of growth coming in that market.

Operator: Scott Davis, Barclays.

Scott Davis - Barclays: Obviously, I think you are going to get a lot of questions just on growth and such, and 2% is a lot better than we are seeing in other companies. But still in that regard, when you think about taking the CapEx numbers the way you have, I think it is about 24% increase quarter-over-quarter. What types of – maybe you can give us some examples of what types of growth projects are you working on, or what type of end markets are you expecting that type of the growth that would justify really ratcheting up spend in a low growth environment?

Inge G. Thulin - Chairman, President and CEO: As we said, we are not changing the guidance for this year relative to the CapEx. And as we all know, the CapEx investment is based on long-term growth. So, that is why we are saying this is something we would continue, and of course, there is some markets that are doing better that need more investment and over time some is more of a challenge, and we will like to build out very much close to the marketing international as we have talked about earlier. So, without going into specific segments per se, you can think about it as we build out our Health Care business on a global basis. We are doing very well in Health Care. We are growing well now, as David referred to, a business where we are growing everywhere both from a business unit perspective and division and on a geographical base. We need to build that out as we move ahead. That portfolio is basically 75% in developed economies. So, the developing world is huge upside for us with very attractive margins. So, you will probably see over time additional investment in that area. In many cases, in order to be successful in Health Care, you need to be very local in order to provide that services. The same go for Consumer. Consumer is another business group for us that are performing very well. Our relative penetration in developing world is much, much lower than in the developed, and specifically versus United States. That's another business over time that we will build out. So, I think you will see that. And then you have to think about one of the strings for 3M is our vertical integration into business model. That means that we will utilize a lot of capacity and places around the world when we build this out. So, I would say that think about it as we are not changing it now because we invest for the future, and the future, we still believe in the plan we have laid out, so it look very favorable for us.

Operator: Nigel Coe, Morgan Stanley.

Nigel Coe - Morgan Stanley: If I look at your full-year guidance, obviously, you maintained that the full year 2% to 5% organic. You've got, I guess, a bit of margin expansion, maybe flat margins for the full year flattish anyway. Given the 1Q performance, and since you still had some of these headwinds on utilization in the second quarter, you got three tough comps coming up in 2Q, 3Q. Are you confident you can maintain flat margins for the full year?

David W. Meline - SVP and CFO: From what we can see now, if you look at the headwinds and tailwinds that we see for margins for the year, Nigel, certainly as we knew would be the case we have some positives in terms of margins year-over-year, in terms of the pension and OPEB expense. As you would note, in the first quarter, we did see continued benefits in our margins from raw materials and pricing. So although we've indicated we think that in our planning that that would moderate through the year, certainly it's notable in terms of support of margins. I think importantly if you look at the headwinds there, we do have some higher level of integration costs of the acquisitions, which we did late last year, so those are hitting more heavily in the first quarter. So that will tend to subside through the year. And then finally, utilization; and the utilization piece, there are several areas where we have underutilization in the quarter, one of them is in the filmmaking equipment. So if you think about the fact that the renewable energy business has seen a quite a substantial downturn, there is inventory adjustments going on in that space that we think will have the biggest impact here in Q1, and to a certain extent still in Q2. If you think about filmmaking for electronics, as we mentioned, likewise, there we see inventory adjustments that have been taking place in Q1, which we think by the midyear those will have been completed and so we'll see a better utilization pattern in that area. Then finally, we do mention industrial and you have some specific areas of industrial, some materials that we make that are specialty materials that go into areas like high-performance gaskets that are used in automotive products where they've had an inventory correction, which now we see that actually will have been completed here by April. So, we see those areas which will enable that underutilization to be addressed and that is, obviously, supportive of margins as we go forward. So, in summary, as we entered the year, we felt good about our ability to continue to deliver both growth and margins, and we continue to believe that's the case.

Nigel Coe - Morgan Stanley: As a follow-on, I just want to tackle Scott's question from a slightly different angle. 2.1% organic growth is actually one of the better ones you've seen so far. But you mentioned that growth is coming in weaker than expected and that continues in the second quarter. I'm wondering to what extent you've managed discretionary cost a bit tighter than maybe envisaged or whether that is an option you can use as we go into second quarter and second half of the year?

David W. Meline - SVP and CFO: So, what I would say is that as we entered the year, we were quite cautious, not dissimilar to how we operated the business throughout basically in the entire 2012. And so we've been managing costs quite cautiously through last year through the first quarter, and frankly, we're in the position now where we'll continue to do that until such time that we see our growth picking up more strongly, which would support incremental investments in certain areas. At the same time, and I think it's apparent and hopefully you picked up from some of our comments here. We have no intention, backing off the investments that we believe are appropriate for the long-term health of the business. So, whether that be building out this emerging and developing market presence, whether that's building out our capabilities with our systems as I talked about, which are significant commitments we are making, ramping up the R&D with a particular focus on the innovation area for some of these longer term breakthroughs. We have the capability to do that and we expect to continue there.

Operator: Andrew Obin, Bank of America Merrill Lynch.

Andrew Obin - Bank of America Merrill Lynch: Just a question on your outlook cut. So we've said that $0.05 is a fact, but we've left the organic growth untouched. So how should I be thinking about the remaining $0.05 cut? Is it margin Electronics or what is it?

David W. Meline - SVP and CFO: Basically Andrew. What we're signaling with the overall cut is frankly a level of uncertainty overall in the business that is a little bit higher than we had when we entered the year. So first of all we've identified specifically $0.05 due to exchange, but quite honestly to pick a point estimate on that number is a little bit difficult to develop that level of precision, but I think directionally we try to size that impact for people so they could understand it. The balance of the cut is really reflecting what has turned out to be some areas of incremental weakness in the business here in the first quarter and the first half, particularly related to the areas in Energy and Electronics we mentioned. So, I would take it as an indication directionally that we think there is more uncertainty out there. Overall, this year then perhaps we expected as we entered the year.

Andrew Obin - Bank of America Merrill Lynch: Just to understand Ceradyne, I guess in your waterfall chart, you highlighted margin drag from M&A, you've also noted that sequestration was a drag, but you've also stated that Ceradyne is performing ahead of your expectations. So, how do I reconcile that?

David W. Meline - SVP and CFO: Yeah, so couple of things. So, if you look at first of all the impact that would impact us from sequestration – first of all, if you think about our business overall we've got about 3% of our worldwide sales are related to the U.S. government that's at federal, local and state levels and about 40% of that which is $1 billion is related to federal. So, we think that the sequestration impact for us would be somewhere in the area of $10 million to $20 million on the year and that would likely be here in the second and third quarters and we are working to offset that with market share gains. Separately, if you look at what's going on with Ceradyne, there is an additional impact. So, if you look at what's going on with troop drawdowns that would impact Ceradyne's revenue, we calculate in the tune of $40 million to $50 million. And so again we are working on offsetting that. This contract that we are able to win for 40 million as it relates to body armor for the Afghanis is offsetting that. And secondly, we've got a series actually last calendar, I think, there are 27 sales synergy programs that the guys have identified with existing and new products from Ceradyne that we can push through our channels around the world for 3M. So, couple of separate issues. If you look at the income of Ceradyne, as we said, while we've got transition costs are better pulling through, the income statement including inventory step up, which still hits us in Q1. We do see that the overall performance on an income basis versus our original acquisition plan for Ceradyne is running ahead of the plan.

Operator: Ajay Kejriwal, FBR.

Ajay Kejriwal - FBR Capital Markets: Maybe a clarification on pricing raws, the comment. Do you expect that's spread to moderate from here or was that more a comment on pricing. And then also what you expect on raws looks like it was a nice tailwind here?

David W. Meline - SVP and CFO: So, in the quarter, we have 0.9% favorable impact on our margin year-over-year combination of both price and raws, as you know, Ajay. If I just take the pieces, first of all on pricing, as we entered the year, we expected to see relatively minimal benefit from pricing through the year, and in fact, Q1 was a little bit better than we expected. As I look at the year on pricing, I would say, it's still too early for me to think about adjusting my view on pricing for the year. And if I look at raw materials, likewise, we did benefit in the first quarter from continued tailwinds from lower raw material costs. We had said for the year we thought we would have a plus or minus $0.05 impact as a result of raw materials and quite honestly there, it depends very much as to the direction of the economy as to how that one is going to play out.

Ajay Kejriwal - FBR Capital Markets: Then on the underutilization of capacity, we've seen that for couple of quarters looks like continues into 2Q. I know you talked about second half pick up. But I guess the question is on the excess capacity, are you positioning yourself for that uptick? Or should we expect some capacity rationalization here?

David W. Meline - SVP and CFO: It's a good question Ajay. So what I'd say is the particular area of that, that we've called out here is in the Energy and Electronics business. What you see happening is that we put those businesses together with a very specific intention to better utilize our assets and more effectively across those segments over time. So, if you think about the assets that we use to support our renewable business and our filmmaking business pointed at the electronic space by having those under a single umbrella what we're already seeing now is the guys are able to even more adeptly manage that capacity. So in this case as we see renewable energy, which is going through a very swift downturn, we've already made some adjustments to our capacity plans, so that we're repurposing that capacity towards other filmmaking activities. What's also true and an example of that would be we have a growing segment right now in the touchscreen area, and so we've already repurposed some capacity that we had originally expected to be adding we've been able to repurpose existing pointed at that touchscreen market. So while we wouldn't foresee right now any need to rationalize per se, what you could see over time, which is a typical 3M type model, which is okay we're repurposing and redirecting capacity towards another business that's growing when we've got one that's not doing as well in the future.

Operator: Stephen Tusa, JPMorgan.

Stephen Tusa - JPMorgan: On the raw mats can you just maybe clarify what was the year-over-year decline in raw mats. I think it was like 3.5% in the fourth quarter. I think you've been giving that every conference call?

David W. Meline - SVP and CFO: That's right. Last year the raw materials and the second half including the fourth quarter was over 3% and a little over – if you look for the full year and '12 a little over 2%. This first quarter we saw that declined somewhat, but it was still over 2% favorable.

Stephen Tusa - JPMorgan: So, the benefit declined somewhat is that what you are saying?

David W. Meline - SVP and CFO: Yeah, the benefit declined still obviously the…

Stephen Tusa - JPMorgan: I got you. And then on your comment on electronics, I guess, you said you expect a similar 2Q to 1Q. Does that mean the similar growth rate or similar just like basically steady from an absolute perspective?

David W. Meline - SVP and CFO: Generally speaking, as we look at the electronics outlook what do we see, we see a first half, second half phenomena quite frankly not dissimilar to what we experienced last year. And if I think about that first half, first quarter, second quarter whether it would be growth percentages, whether it would be dollar numbers, we think that it's going to be pretty stable through the first half.

Inge G. Thulin - Chairman, President and CEO: That is very consistent with external data that you see, right. So, I think, that's (just rolling) for us. That's also why we are very cautious, right. So, we do not see it yet, even if there is some hopes for the future there. So, that's why we kept on moving forward.

Stephen Tusa - JPMorgan: Then lastly just you did say corporate was still guided $350 million to $400 million?

David W. Meline - SVP and CFO: For the year, that's correct. So, if you look at the quarter, it was a little lower because of some things that happened in Q1 of last year. We think for the year $350 million to $400 million.

Stephen Tusa - JPMorgan: So, with these dynamics, will you guys grow earnings in the second quarter?

David W. Meline - SVP and CFO: Certainly, we are holding our guidance for growth for earnings for the year $6.60 to $6.85 versus $6.32 last year. We saw a modest growth of income in the first quarter, and quite frankly, we're driving to generate earnings and growth every quarter, and that will certainly include the second quarter.

Operator: Jeff Sprague, Vertical Research Partners.

Jeffrey Sprague - Vertical Research Partners: Just a few questions, if I could. Just R&D tax credit, it didn't appear you guys had any benefit in the quarter. Why is that and is there something that follows subsequently?

David W. Meline - SVP and CFO: Yes. So, (Steve), on taxes, what's true is actually the R&D, the pickup we got for the deferral of the extenders actually was beneficial to us in the first quarter by 1.7%. So, inside of that first quarter 29.1%, we did have a benefit. But what's also true is if you look at the first quarter, the underlying run rate was closer to 31% for the quarter. Typically our highest tax rate is in the first quarter of each year and it moderates through the year. So we expect 29.5% to 30% for the full year, same as we had originally set out. We think it'll run fairly stable through the year.

Jeffrey Sprague - Vertical Research Partners: Then just on Japan and the yen situation, obviously, the translation is understandable, the mathematical exercise. Are there any particular export opportunities for you out of Japan that are new or different around the yen weakness that could possibly be a mitigating factor?

Inge G. Thulin - Chairman, President and CEO: Let me make some comment on Japan in a bigger picture. We have – what is happening in Japan now is something that we, in a way, could predict quite some time ago. So, we have worked on Japan as a business for quite some time. In fact, we started in the beginning of 2009 was when we took a big charge in order to reset our operation there. Since that, we have done a lot of things in order to make sure that we have a better competitive position in Japan. That have been resetting of the manufacturing footprint; we made an acquisition later, as you recall, A-One, which is into the Consumer business group. We have started to shift our resources, I would say, to more domestic businesses. For us, more domestic will be the Consumer business, the Health Care business, and some of the Safety businesses, while we have really put emphasis on the local manufacturing for automotive specifically and Electronic area per se. So, we have been working this for a quite some time. And when we look upon our results in Japan, the interesting thing for us is we look now in terms of growth for Health Care for the quarter was over 6%, for Consumer over 7%, and so we get traction there. I think we are very well set for the future in Japan, but it will take some time for us. Now for them, I think, when you talk about export and import in and out of Japan, this will take some time for them to get their plan working. So, we hear good thing. If you have interacted and worked with Japan over time, you also know this will take some time before there would come traction. But, generally speaking, we have a good, solid manufacturing footprint in Japan that we can capitalize on already now if it pick up for them in terms of domestic manufacturing, which is what they will like by definition. That's what they are driving at. So we have – in fact, our biggest super hub in the world is in Yamagata in Japan. So, we have incredible capabilities there already now to capitalize if they will take-off, which we assume they will in terms of domestic manufacturing. I hope that helps in terms of…

Jeffrey Sprague - Vertical Research Partners: That does. Just one other quick follow up. David, can you just give us some color on what the share count that's implicit in your guide? The reason I ask is it looks like you had a lot of options exercises and everything. You actually did more than a quarter of your annual buyback in the first quarter and your share count is up sequentially.

David W. Meline - SVP and CFO: Yeah, so what I would say, Steve, is the guidance we gave, which still looks good for us, is a gross buyback of 2 billion to 3 billion for the year and, as I said earlier, we're running as you can see at the high end of that range. If you look at the net buyback that we called out, I think it was around 1 billion to 1.5 billion for the year. And, in fact, you are right, we expect that to be towards the reissuance towards the high end, in that there was a lot of reissuance this first quarter as we saw record share price for the Company. So, I don't know how to predict, how that's going to play out, but we're continuing to maintain our view that both gross as well as net we'll be able to achieve the original allocation plan we had set out.

Operator: Joe Ritchie, Goldman Sachs.

Joseph Ritchie - Goldman Sachs: So, just a clarification on Electronics and Energy. If we are forecasting a similar growth rate for the second quarter, even the low-end of your guidance then implies roughly 4% growth in the third and fourth quarter, and so my question is really regarding your confidence around that. And then, specifically how that relates to the margins as well, because based on the data we have it looks like this is the lowest margin quarter we've seen in this business over the last 12. So, would love to get some color on the trajectory of margins there as well.

David W. Meline - SVP and CFO: Yeah. Maybe I can address that, Joe. So, if you look at the Electronics and Energy business, a couple of, I think, relevant kind of context points. One is, as we did enter the year, we did put the widest range on sales growth of the five sectors we defined around this business, because it was our perception that there was some uncertainty coming into the year. So, we've got – if I recall 1% to 6% for the year is the range. We continue to believe that that's a good range for this segment, despite having run below that, obviously, in the first quarter and we expect to run at a low-level in the second. So, we do expect to pick up in the second half, which again is, I think, not inconsistent with indicators that you would observe elsewhere. In terms of the margin performance for the business, as we kind of set up the year and tried to give some indication as how we thought that would develop, we did indicate that we thought E&E for the year would have margins below the Company's average, in fact, in the high teens. We continue to expect that to be true. So, I think you can infer that you'll see a first half, second half pattern both in growth as well as the consequent margins related to that sector.

Joseph Ritchie - Goldman Sachs: I guess one follow up on the margins. Your Health Care margins have been strong for several quarters, saw bit of a downtick on a year-over-year basis. Any color you can provide there on mix that would be very helpful?

David W. Meline - SVP and CFO: So, I guess what I would say on Health Care margin, likewise we had indicated we thought this year we would continue to run at similar margin levels as we've seen through last year, which has been 30 plus for that sector, even though we think maybe long-term view is a little bit below that. You did see it come down a little bit in the quarter year-over-year. Certainly we have identifiable aspects one being a 0.4% impact of the new device tax on a year-over-year basis. As I mentioned the ERP cost that the businesses are picking up in the first quarter creates an additional 0.3% headwind on a sector margin basis in the first quarter and that will continue. So if you think about those couple of factors in the context of the overall margin performance, I think you could and you should take away a view that we continue to believe that the business in the sector is very healthy and will run pretty stable at a high level through the year.

Inge G. Thulin - Chairman, President and CEO: And in addition to that as I made in my comments that we are giving additional investment to some of the push forward businesses and the Health Care is, of course, one of them, right. So, we are very positive around the outlook for Health Care. So, we are not only pleased with current performance, in fact, I would say, I'm very, very pleased with current performance in Health Care, but the outlook is also very, very solid for us. So, we are supporting that business, they are on push forward, we are moving resources very cautiously in order to make sure we get productivity at the same time as we build out and most of the build out is in developing economies and in international broad based and as you know 75% of our portfolio today is in developed world. So, as those economies now start to be ready to take on more advanced Health Care, and we have a very good value proposition with our product line broad-based I would say in both the hospital supply and in the orthodontic field as well as in food safety. So, it looks very good for us as we move ahead.

Operator: Scott Davis, Barclays.

Scott Davis - Barclays: I wanted to follow-up on this U.S. medical device tax, and is this somewhat of a timing issue or it just takes you a while to pass this on to your customers? Or is this something you got eat for a while until you anniversary it?

David W. Meline - SVP and CFO: Yeah. Great question, Scott. I guess we don't think about it has a pure pass through that you receive a cost increase and then you pass the price through the market. Our view is that we need to look at the offerings that we provide to the market. We need to remain competitive. We need to make sure we manage our cost, so that we get a margin for our efforts. So, I don't think of them as having such a direct relationship, if you will.

Inge G. Thulin - Chairman, President and CEO: As you probably know, in that field specifically, in the Health Care field it's very difficult to pass it on because you have to pass it on then in terms of price increases, right?

Scott Davis - Barclays: Yeah. I'm sure that's going to be tough.

Inge G. Thulin - Chairman, President and CEO: So that's tough. And if you look upon the price increases for Health Care as you stand into the year, they are able of course, to take a little bit higher in the developing world versus in United States. So, I think it's correct as David said. It's nothing we ask him push on. We need, however, to drive efficiency in the manufacturing operations, which I would say in the Health Care space is a very attractive operation for us, right. So, one of the reason why we are successful there, we have very high margins is many things in addition to the value of the product, that is also very good manufacturing operation. As you know, we can always do more and we have Lean Six Sigma all over that in order to improve even more. So, I think that's how we need to compensate those type of things that we cannot control.

Scott Davis - Barclays: Just a real quick one. When you look across the companies that we cover, it seems that you guys get a little bit more stock dilution and the average on (indiscernible) option plans and share offerings – and share grants and stuff. Does that start to tail off over time and I guess my point being as your compensation strategies change either to be more cash based and less option based or is it just kind of how it is and (indiscernible) model that type of dilution going forward?

David W. Meline - SVP and CFO: No, it's a good question. So, a couple of comments. One is, if you look at on an overall basis the historical pattern of the share count, we over the last decade have seen a decline typically on average around 1% annually. As we look at -- we looked into this next five year plan that we talked about late last year, our current expectation is that decline will increase somewhat to 1.5% to 2% area going forward. That's a few things. One is, as we think about how we allocate capital in that direction. Secondly, importantly, there've been some changes to the compensation plans that have been put in place over time, so for example in 2007 there was a change in terms of the mix of comp, which resulted in the number of options being granted to be reduced in about in half. So it's a little bit like a little longer-term phenomenon, but we're now seeing coming to a step down in terms of the overall number of options that are outstanding, and have not been reissued the shares yet. So, if you look at the first quarter to your comment, quite frankly, with the way the stock price performed, we saw a lot of reissuance occur then. So, we think that the total outstanding on extra side count of options probably will be cut in half by year-end from where it was as recently as a few years ago.

Operator: Deane Dray, Citi Research.

Deane Dray - Citi Research: Covered a lot of grounds, just a couple of clean-up questions here. First for David, could you update us on the currency hedging that you do have in place and is it fair to say you've got about half of your yen exposure hedged?

David W. Meline - SVP and CFO: Yeah, so we continue with the same approach that we've had in the past, which is on a rolling basis to be hedging 50% of our exposure, so that would certainly include the yen. I think more specifically, if I look at the pattern and we compare the impact of this devaluation on a year-over-year quarterly basis, what we do see as we called out $0.05 headwind year-over-year now as we move through and that's concentrated in the first half. Specifically, we think we'll have – if exchange rates stayed at a similar level to where they ended these recent days, we would expect to see something akin to $0.03 to $0.04 of that impact impacting us in Q2.

Deane Dray - Citi Research: Would that also show up as your mark to marketing these currency contracts or would they roll off and it's a P&L impact?

David W. Meline - SVP and CFO: It would show what happens as we have hedge accounting treatment on both the exposure and these matching hedges. So, that's how we are able to predict as I just described the P&L impact in the second quarter because we know what those unrealized gains and losses are and so if exchange rates are unchanged as we move forward, those contracts will be maturing throughout the year including the second quarter and therefore what I'm referring to is the unrealized gains and losses that we can see on the book right now.

Deane Dray - Citi Research: Then just my last question for Inge. I was hoping you could update us on the portfolio review. We've seen how you've gone through the self-fix combined process with traffic and security being combined, but what else is on that hit list and where do you stand in that review process?

Inge G. Thulin - Chairman, President and CEO: Yeah, I don't know. I don't refer them as a hit list. I like most of those businesses as you know all of them make money, all of them are good, but they are in our word, they are below average relative to performance. We are looking our way through there and I would say we take them business-by-business. I have not announced the specific timeline because as you know the business is not conducted in that way. So, I will let you know after we have let internally and people know if there is some changes coming there. But the point I can tell you which is very encouraging is that those businesses have improved dramatically the performance in the first quarter versus a quarter ago. So, they got tougher target and they meeting those targets. So I think that's good. Now, the (Heartland) and push forward, the (Heartland) divisions had a very good performance in the first quarter. In fact as David said, our biggest division in the Company industrial adhesives and tapes had over 7% growth. So, yes fantastic. But that category is doing very well. On push forward, I would say as that is lower leverage for us, we are allocating resources, that is more to come in terms of execution of the plan. Point is, we are very focused on it, we spend a lot of time, they have different measurements and people know it, right? I think that's the key element on how we are driving this forward. So, I'm very encouraged around it because both myself and David and the whole management team believe in this approach in order to improve the portfolio and the performance of the Company. So, rest assured we are on it and as some announcement is coming you will know is one of the first when we have told people internally.

Operator: Laurence Alexander, Jefferies & Company.

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

Inge G. Thulin - Chairman, President and CEO: We probably don't look upon I product line by product line, we have followed from the market perspective. I would say that we have very good customer insight and interaction with customers. So we are able to follow they well. I think one of the advantages for us is the closeness that we have to our customers and the customer intimacy based on lot of technologies that we are working together with them on both on platforms that they are developing which is an indicator of when can that be launched, yes or no, and also consumables in the industry. So, we can have some businesses that we will see an early uptick that is a good indication, but I will not say we are not following it that way we take an approach of following each marketplace, if you like, and get solid input and then have those dialogues which is a combination of external facts and data and what our teams are talking about. So, that's the answer to that question.

Matt Ginter - VP, IR: Excuse me, we ran a little late, but we had a lot of questions and they were good questions. So, thanks for those and thanks for joining us today. And appreciate you are listening in. Bye-bye.

Operator: Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.