3M (MMM)

Q2 2011 Earnings Call

July 26, 2011 9:00 am ET

Executives

David Meline - Chief Financial Officer and Senior Vice President of Finance

George Buckley - Chairman of the Board, Chief Executive Officer and President

Matt Ginter -

Analysts

Terry Darling - Goldman Sachs Group Inc.

Scott Gaffner - Barclays Capital

Shannon O'Callaghan - Nomura Securities Co. Ltd.

C. Stephen Tusa - JP Morgan Chase & Co

John McNulty - Crédit Suisse AG

Steven Winoker - Sanford C. Bernstein & Co., Inc.

Ajay Kejriwal - FBR Capital Markets & Co.

Jeffrey Sprague - Citigroup

Laurence Alexander - Jefferies & Company, Inc.

Unknown Analyst -

Deane Dray - Citigroup Inc

Presentation

Operator

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Ladies and gentlemen, thank you for standing by. Welcome to the 3M Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, July 26, 2011. I would now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.

Matt Ginter

Hello, everyone, and welcome to our second quarter 2011 business review. Today, we'll review our most recent results, along with an updated outlook for the rest of this year. A PowerPoint presentation accompanies today's conference call, which you can access on 3M's Investor Relations website at 3m.com. Today's slide presentation and the audio replay will be archived on our website for an extended period of time.

With me today are George Buckley, 3M Chairman, President and Chief Executive Officer; and David Meline, our Chief Financial Officer.

Please take a moment to read the forward-looking statement on Slide #2. During today's conference call, we will make certain predictive statements that reflect our current views about our future performance and financial results. We base these statements on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K list some of our most important risk factors that could cause actual results to differ from our predictions.

So with that, let's get started, and I'll turn the program over to George. Please turn to Slide #3.

George Buckley

Thank you very much, Matt, and good morning everybody. Thanks for joining us today. We really appreciate it. For the numbers, this was another very good quarter for 3M. Sales rose 14% to $7.7 billion, an all-time high for any quarter in history. We were on track for $30 billion plus in sales for the year. Operating income was $1.7 billion and margins were nearly 22%, with 5 businesses above 20% for the quarter and the sixth one knocking on the door. We posted earnings per share of $1.60, an all-time record in the second quarter for us, and we returned $1.1 billion in cash to shareholders via a combination of share buybacks and dividends.

Free cash flow was $1.2 billion, and we converted 100% of net income to cash in the quarter. What is most impressive is that we achieved these results in the quarter that had more than its fair share of challenges. If you'll recall that in our April earnings report, we described some of the headwinds that we expected would affect the second quarter, and in fact, they played out largely as we expected. We knew the second quarter was going to be the nut hole of the year. And if we could do reasonably well going through it, we'd likely do okay in the balance of the year.

For example, in Japan, we expected and outlined that the knock on effects of March's earthquake would be at their worst in the second quarter. They're getting as the year went on. We estimate that this temporarily reduced our sales growth in the quarter by just under 2.5%, margins by 50 basis points and earnings by $0.07 per share. We expect that these impacts will weigh in the second half of the year, and in fact, there is reason for hope beyond that as the reconstruction phase begins. We're also more optimistic on the recovery of insurance claims.

Also in the quarter, as we anticipated, we experienced few orders for optical films, LCD TVs. The LCD TV business is a cyclic business is a cyclic business with the periodicity of about 2 years late over the general economic cycle and is simply going through one of those down cycles that reflect the inventory corrections, and ultimately a less robust consumer end market.

Recall please that last quarter, we describe the LCD deep channel as fault, and with about 3 weeks excess inventory on hand. And we know that this always comes with pricing attachment rate pressure. This is a business where the retailers make 4% margin with 15% to 20% down price annually or 4%, if you like, in 1 quarter. Retailers and set manufacturers must correct quickly in these situations to stay in business, and in fact, they did respond with sharp production cuts in the second quarter. When they do, it gives us fits and starts. On the whole, our optical films sales declined by 22% in the second quarter, causing a 1.3% drag on organic growth.

LCD TV, however, remains a fundamentally good industry, driven by innovation, an OEM seeked a part with 3M to make that innovation happen. And overall, optical is a fine business with $1.6 billion in annual sales with operating margins in the 20s. However, we do sense some weariness among some of the OEMs, as TV prices begin to approach bottom and the asymptote of total cost in prices reached. I believe in the future, the market will bifurcate or trifurcate into performance, mass and entry markets. There are very definite signs that one or more manufacturers will begin focusing only on the high-performance segment, and ultimately, we're being more value-add, more features, better pricing and some overall stability to the market. This is a market primed for a new entrant with a unique value proposition. But for now, LCD TV is less than 40% of our optical film mix and other applications such as smartphones and tablet PCs continue to grow very nicely.

I will start this next part of my talk by reminding listeners that I'm not an economist. But on the economic front, there is no doubt that Q2 data suggests global economic growth moderated. And we felt that within our results. You have to be careful not to let the Japan and Optical issues cloud the 3M data. Beyond those more obvious impacts, it appears that consumer related end markets, particularly consumer electronics, are feeling the effects of stress. With our product and market mix, we tend to see those impacts come and go quite rapidly. As a team, we have a collective view that things were just a little bit harder in Q2, no collapses, no catastrophes, just that bit tighter.

We've all seen this economic phenomena before and very clearly so in the last 2 economic cycles. Both recoveries were initially very fast and experienced big jumps in profits, then, too, in oil and commodity prices. Last time, it was also complete by higher interest rates. These various forces was things like increased consumer savings rates, all impact the consumer's ability to spend money on other things.

As each transient ebbs and flows occur, the economy often takes a breather or pause, if you like, as it gradually adjusts to the new realities around costs, interest rates, credit and prices. Economic recoveries are never leaner, and along these recovery path line are intermittent periods of slow growth, still growth, mind you, but only slowing. This is how we view today's situation. We believe that global economy's in a slow spot for a while, but will reaccelerate again as commodity prices ease, fuel cost reduce and spending is redirected elsewhere in the economy. So nothing has fundamentally changed, and we are well positioned to capitalize on that growth and certainly more so than others.

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