Q1 2006 Earnings Conference Call Transcript
Mark Colin- Director, Investor Relations
Good morning, I'm Mark Colin, Director of Investor Relations for 3M, and welcome to
our first quarter 2006 business review. Before we begin, I have a few brief
As in prior quarters, today’s discussion will follow a series of PowerPoint slides, which
are currently available on our investor relations website. Looking ahead, our 2006
second-quarter earnings conference call will take place Tuesday, July 25th. Please mark
your calendars accordingly.
During today’s conference call, we will make certain predictive statements that reflect
our current views and estimates about our 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. Also, as we discussed in our
2005 10K, effective January 1st, we combined our Industrial and Transportation business
into one business. The new business leverages common markets and customers, as well
as common channels, technologies, manufacturing base and selling processes. In
addition, during the first-quarter the Personal Care and Related Products Division within
the Health Care segment transferred to the combined Industrial and Transportation
And finally, beginning in 2006, we adopted the expensing of stock options and have
elected to restate prior periods. Our comparisons and historical information included in
our press release and also provided via Form 8K published earlier this week have been
adjusted for these realignments.
George Buckley, 3M’s chief executive officer, and Pat Campbell, our CFO will handle
the formal comments of today’s call and then we will open it up for Q&A. And now I'd
like to turn the program over to Pat.
Pat Campbell- Chief Financial Officer
Thanks Mark, and good morning everyone. Let’s begin with some key highlights from
the first-quarter. Please turn to slide number two.
This was an outstanding quarter for 3M. Sales reached an all time high of $5.6 billion, up
8.3 percent over the first quarter of 2005. In local-currency terms we generated sales
growth of 10.4 percent, including 2.3 percent from acquisitions, primarily CUNO. Our
organic local-currency growth of 8.1% in the first quarter was the highest since Q2 2000.
The real highlight this quarter, from both a business segment and geographic perspective,
was the breadth of this outstanding performance. All six of our businesses delivered
strong local currency sales growth, ranging from Health Care, which was up 4.9 percent,
to Safety and Security which experienced local currency growth of over 15 percent.
On a geographic basis, organic local-currency sales growth was 12.0% in Asia Pacific,
7.9% in Europe and 7.4% in the U.S. The timing of the Easter holiday had a favorable
impact in the quarter of approximately 1% on our overall growth rate.
And this is not just a sales growth story. We had an outstanding quarter on the income
side as well. Operating income in the first quarter was $1.4 billion, up 18.8%. Four of
our six businesses posted double-digit operating income increases, and this was 3M’s
17th consecutive quarter of year-over-year earnings and margin expansion.
Reported EPS came in at $1.17, up over 20%. Included in this result is $0.02 of option
expense for first-quarter 2006 compared to $0.06 for the first-quarter of 2005. The year-
on-year decrease in option expense this quarter is a result of a change in our options
vesting period from one year to three years starting with the May 2005 option grant.
Another highlight this quarter was our board’s action in February authorizing a dividend
increase of 9.5% for 2006. This marks the 48th consecutive year of annual dividend
increases for the company.
As we commented in our press release on April 4th, we are pursuing strategic alternatives
for our branded pharmaceuticals business. This business has been very successful,
however, its investment and risk profiles are different than most other 3M businesses and,
frankly, we feel that the best way to maximize value is to combine it with a dedicated
pharmaceutical company. We have engaged Goldman Sachs to lead the process for us.
As you can tell from these results we are off to a great start in 2006, and our performance
this quarter gives us tremendous confidence in the ability of our teams around the world
to drive accelerated growth, which continue to achieve superior financial results.
On slide three we recap our first-quarter sales performance on a geographic basis.
As I previously mentioned, worldwide sales in dollar terms increased 8.3% versus last
year’s first-quarter. Volumes increased 10.4%, with core volumes up 8.1% and
acquisitions adding 2.3% to growth. Selling prices in the quarter were flat while year-on-
year currency translation reduced reported sales by 2.1 percentage points.
In the United States, sales improved 10.8% vs. last year’s first-quarter. Organic local
currency growth in the quarter was 7.4% with volume up 5.3% and selling prices adding
2.1%. This is the highest organic local-currency sales growth in the U.S. since the first-
quarter of 2000. U.S. organic growth was strong across the portfolio as five of our six
businesses delivered double-digit organic local-currency growth. Acquisitions added
3.4% to growth in the U.S. in the first quarter.
Sales in our international operations were up 6.8% in U.S.-dollar terms. Local-currency
sales were up 10.3%, with organic volumes increasing 9.8% and selling prices decreasing
120 basis points. Acquisitions added 1.7% of additional growth. International selling
prices continued to be negatively impacted by our businesses that serve the consumer
electronics industry. However, our total revenue growth in our consumer and electronics
related businesses remained strong. Currency translation reduced first-quarter sales by
Organic local-currency growth was 12.0% in Asia Pacific, with Japan up almost 3.0%,
and the rest of the region up 18%. Acquisitions added 1.8 points of additional growth in
the quarter. All six of our businesses posted positive local-currency growth in Asia
Pacific during the quarter.
Europe delivered 7.9% local-currency growth, its best result since Q2 of 2000.
Acquisitions added an additional 1.6% to growth in Europe in the first quarter. Since
Easter is in the second-quarter this year compared with the first-quarter last year, first-
quarter local currency growth in Europe benefited from additional billing days. We
estimate the Easter benefit to Europe’s first-quarter local-currency growth to be about 4
And finally, we posted 1.2% organic local-currency growth in the combined Latin
America and Canada. Excluding the impact of the decline in our CRT rear projection
lens business in Mexico and the move of a flex circuit customer from Puerto Rico to
Singapore, the Latin America Canada region’s organic local-currency increased 5.2%, led
by Consumer and Office, Health Care and Industrial and Transportation businesses. The
CUNO acquisition added an additional 1.7% to growth in the quarter.
On slide number four, we compare our first-quarter P&L versus last year’s comparable
quarter. Again, note that we elected to restate prior periods for the expensing of stock
options. Therefore all numbers shown from this point on will reflect this restatement.
As I previously mentioned sales were up a strong 8.3% year-over-year.
Gross margins were 51.4%, up 70 basis points from last year’s first quarter. This
improvement was the result of continued focus on driving productivity in our factories,
along with volume and mix benefits, which more than stayed ahead of inflationary
SG&A expense was 21.1% of sales, down 1.1 percentage points despite our investing
rather aggressively in areas where there is clear line of sight to revenue growth – namely
advertising, promotional programs and feet on the street. We kept a tight lid on
administrative expenses in the quarter, and lower management stock option expenses
accounted for 60 basis points of the year-on-year improvement.
Excluding options expense in both years for R and D and related expenditures, they
increased almost 4.0% year-over-year, as we continue to aggressively invest in future
growth for the company.
Operating margins continue to expand, finishing at 24.5%. Lower cash balances and
higher interest rates drove up first-quarter net interest expense, which was $14 million
versus $4 million last year.
3M's tax rate for the first quarter was 32.7%, up just slightly from recent quarters. Aside
from the impact of stock options, the tax rate reflects a 30 basis point increase due to the
expiration of the R&D and Orphan Drug Tax Credits on December 31 of last year. In the
event the IRS or Internal Revenue Code is amended to reinstate these credits, the
corresponding positive impact would be reflected in our tax rate in future quarters.
Quarterly net income increased 16.6% year-on-year and earnings-per-share increased
20.6%. These results include a $17 million after-tax impact, or $0.02 per share, due to
expensing of stock options in this year’s first-quarter versus $38 million after-tax, or
$0.06 per share, in last year’s first-quarter. We have provided future stock option
expense detail in the attachment to this morning’s press release as well as the 8K
published earlier this week.
The P&L on a sequential basis is found on slide number 5 and reflect solid improvements
in all categories.
Sales were up 5.1% versus the fourth quarter of last year, as five of our six businesses
drove positive sequential growth. We leveraged this increase into a 15.0% operating
Operating margins improved by 210 basis points sequentially, driven by a combination of
accelerating sales and ongoing productivity.
On a sequential basis, net income and earnings-per-share increased 15.2% and 15.8%,
respectively. These results include a $0.02 impact from the expensing of options in each
Now, if you would turn to slide number six, I will review a few balance sheet and cash
Our net working capital turns were down reflecting higher volumes and our strategy to
improve customer service to drive further growth. Many of our supply chains are
currently constrained and we are building inventory in some cases to meet anticipated
higher demand. We have approved additional capital expenditures to increase capacity
but it will take awhile before this capacity is in place.
Capital expenditures were $190 million in the first-quarter. We expect our capital
expenditures to accelerate throughout 2006 to approximately $1.1 billion for the year,
which would be a 16% increase year-over-year. This acceleration is demand driven, as
our capital needs are to a large extent supporting growing businesses such as optical
films, medical products, commercial graphics, Scotch blue masking tape, roofing
granules, respiratory protection products and Filtrete filters to name a few. And the rapid
growth in developing economies, one of 3M’s most significant opportunities for
sustainable top-line growth, is also fueling the need for additional capital over the next
First-quarter free cash flow of $435 million was lower than last year for two primary
reasons. First, as I just mentioned, we invested in working capital in Q1 in anticipation
of continued firm sales volumes. Second, we made higher estimated tax payments to the
IRS in the first quarter vs. the same quarter last year, primarily related to our record level
of dividend repatriation from foreign subsidiaries back into the U.S. during the last half
of 2005, including the portion related to the American Jobs Creation Act.
We paid $347 million in dividends to our shareholders in the first-quarter. Our stock
repurchase activity during the quarter was low as we were out of the market for awhile as
we were formulating our decision on Pharmaceuticals business. As a result, our share
repurchases were $251 million with a net repurchase of $151 million during the quarter.
Weighted average diluted shares outstanding were 768.6 million, down about 2.3% from
last year. Our debt to capital ratio was 19.3% at the end of the quarter.
Please now turn to slide number 7, where we will examine our results by business
segment. Please note that we have added an additional column to our business results
chart this quarter to reflect the year-on-year percentage operating income impact from the
expensing of stock options for each segment to help in better understanding our results.
For example, our Industrial and Transportation business operating income growth was
5.5% higher due to the impact of lower stock option expense in Q1 2006 vs. Q1 2005.
As I mentioned we moved from a one-year to a three-year vesting period which resulted
in a lower option expense in the first quarter of 2006 compared to the first-quarter of
2005. And now I would like to turn the program over to George to discuss our
performance by business. George……
George Buckley- Chairman, President and Chief Executive Officer
Thank you very much Pat and good morning everyone.
Our Industrial and Transportation business delivered a strong quarter with local-currency
sales growth of 14.0% including 7.5% from the CUNO acquisition. Operating income in
the first-quarter was $381 million, or up almost 24.0%.
Growth in this segment was led by CUNO, complemented by strong performance in our
industrial adhesives and tapes business, and our automotive aftermarket division where
innovative products such as our new paint preparation system are driving growth by
improving the productivity of our customers. The CUNO acquisition continues to meet
our expectations with local-currency growth of over 14% versus the same quarter last
year when CUNO was an independent company. We remain excited about CUNO’s
tremendous growth prospects, particularly in emerging markets.
As we have mentioned in some past quarters, our Personal Care diaper tape business
sales have been declining as we have lost volume due to our pricing strategy aimed at
improving the profitability of the business. I think it’s also fair to say that we didn’t
event as much as we should’ve in this business. We continue to work hard to recover
volume over time by bringing new products to our customers that we believe will make
us more competitive but this will take a little while. The sales decline in our personal
care business negatively impacted Industrial and Transportation’s segment growth by
1.4% in the quarter.
The Health Care business got off to a good start to the year with sales of $966 million in
the quarter, up 4.9% in local-currency terms. Operating income increased almost 10% to
$298 million year-on-year. Excluding our pharmaceuticals business, which is
approximately 20% of Health Care, our first-quarter local-currency sales were up 6.8%
with operating income remaining at about 10%.
Worldwide local-currency sales in our medical and dental businesses grew at double-digit
rates in the quarter. Growth in Health Care was driven by the strength of our infection
prevention and acute wound care products, our leading technology positions in new
products such as Littman electronic stethoscopes, and our innovative dental products such
as our Lava crowns and bridges digital dentistry system. Geographically, local-currency
growth rate in our Health Care business was led by the Asia Pacific region where we are
focused on driving infection prevention and dental platforms into the rapidly growing
health care markets in the developing countries. Also, during the quarter we announced
that we have successfully closed the acquisition of OMNII Oral Pharmaceuticals.
Adding OMNII's preventive expertise, products, and capability to educate, will enable us
to deliver even more value to dental practices while participating in a rapidly growing
segment. We are committed to continuing to strengthen and expand our position in the
As we commented in our press release on April 14, April 4th, forgive me, relative to our
successful branded pharmaceuticals business, in today's very competitive pharmaceutical
marketplace, continued success requires broad pipelines of new drugs, significant
investments, and a longer term risk-reward business model than applies to most other 3M
businesses. We believe that the best way for this business to grow is for it to be free to
pursue separate strategies under the direction of a dedicated pharmaceutical industry
company with a business model better suited to maximizing its potential. We feel the
business is a very valuable asset and there are more opportunities for technology and
market synergies with a company other than 3M. So, as Pat mentioned earlier, we have
engaged Goldman Sachs to lead the process for us. We will provide further updates to
you as warranted as we work our way through this process.
Moving on, Display and Graphics had another outstanding quarter with local-currency
sales growth of 9.5%, to $915 million. First-quarter operating income was $296 million,
up almost 4%. As in past quarters, sales and operating income in Display and Graphics
was dampened by the continuing decline of our CRT rear projection lens business.
Excluding the negative impact of that business sales and operating income would have
been up a very nice 13.0% and 12.1%, respectively.
Matching last quarter’s record, the ongoing strength of the consumer electronics industry
drove demand for our proprietary optical films and components business. We
experienced all time record first-quarter revenues in the film business as we posted
double-digit local-currency growth in the quarter. This business is driven in part by the
strength of a rich intellectual properties portfolio that we are continually expanding upon.
Focused capital investments are also being deployed to accelerate commercialization of
the next generation reflective polarizer films to meet the long-term cost and performance
requirements of the growing LCD-TV market. Pricing in our LCD films business
remained at a similar rate to last quarter as a result of normal industry pricing pressure.
Commercial Graphics delivered strong local-currency growth in the first-quarter with
strong end market penetration and differentiated products that offer superior value to
And finally, Traffic Safety Systems continued the momentum from the second half of last
year with a continued focus on innovative new products such as diamond grade reflective
Consumer and Office’s organic local-currency sales growth of 8.1% was broad based
across the portfolio. The acquisition of InterChemall, a Polish manufacturer of home
care products, added an additional 30 basis points of growth in the quarter. Operating
income in Consumer and Office was $136 million, up over 19%.
In Consumer and Office we continue to penetrate our large key accounts with new
products with unique functionality along with customer inspired design. Our Consumer
and Office team has developed a strong track record of introducing innovative new
products such as the recent launch of Post It Picture Paper, which is being supported by a
national advertising campaign. Our line of Nexcare consumer health care products was
another notable growth driver in the quarter.
Our Visual Systems business, primarily analog overhead and electronic projectors and
film, continued to experience a decline reducing overall Consumer and Office Sales by
1.7% in the quarter.
Safety, Security and Protection Services business had an outstanding first-quarter. Local-
currency sales increased 15.6%, to $631 million. We continue to invest in additional
capacity here, particularly, for our respiratory and roofing granules businesses, to support
higher end market growth. Profits globally improved 30.3% year-on-year to $164
Geographically, local-currency growth was positive across all regions led by Europe,
Asia Pacific and the U.S. We experienced broad based growth in safety solutions,
including respiratory, hearing, eye and face protection, along with robust demand for our
cleaning and protection products for commercial and residential buildings.
For the second consecutive quarter our Electro and Communications business delivered
double-digit organic local-currency growth. Organic local-currency growth in the quarter
was 10% with an additional 70 basis points coming from our acquisition of flexible
circuit technology for ultrasound machines from Siemens. Electro and Communications
leveraged this growth and a continued focus on productivity into a 33.2% improvement in
operating income to $127 million.
This result was driven by outstanding growth in consumer electronics, where our
products such as Form-In-Place Gaskets for sealing hard disk drive covers, flexible
circuits, films, adhesives and tapes for bonding, protection, and vibration dampening
solve the unique needs of our diverse and global electronics manufacturing customers.
We also had excellent local-currency growth in our Electrical Markets business, where
we offer a wide array of insulating, testing, and sensing solutions to the electrical utility
and infrastructure industries.
If you’d now please turn to slide eight, where I will discuss our guidance for the second-
quarter and the remainder of 2006.
Looking ahead to the second-quarter, we expect business conditions to be very similar to
what we saw this past quarter. We expect second-quarter organic local-currency growth
of 5.0 to 8.0 percent with acquisitions adding an approximately an additional 2.5 points
of growth. Second-quarter growth will be negatively impacted by approximately one
percent due to Easter now being in Q2.
Second-quarter earnings-per-share are expected to be in the range of $1.14 to $1.17,
including $0.08 per share impact from stock options expensing. 2005 second-quarter
earnings-per-share, restated to reflect stock options expensing of $0.04 per share, were
$1.06. As Pat discussed last quarter, we will have some lumpiness quarter-to-quarter in
our options expense, particularly in the second-quarter due to a requirement under
FAS123R to immediately expense stock option grants for those employees who are
considered retirement eligible. A 3M employee is considered to be retirement eligible
upon reaching age 55 with 5 years of service. Approximately 25-30% of the annual grant
award is to these employees. Since we grant our employee stock options in the second-
quarter, the immediate expensing stock option grants to retirement eligible employees
results in higher stock option expense in the second-quarter. Accounting rules do not
allow restatement for the retirement eligible impact.
Building on our strong first-quarter performance, we now expect full year 2006 earnings-
per-share to be within the range of $4.55 to $4.65, including a $0.16 impact from option
expensing in 2006 and $0.14 in 2005. Organic local-currency growth is expected to by
5.5 to 8.0 percent with closed acquisitions adding approximately an additional 1.5 points
During the second-quarter, we anticipate that we will likely resolve several outstanding
items. First of all we expect the favorable completion of a number of worldwide tax
audits. Next, we are scheduled for a late spring trial of a certified class action brought by
direct purchasers of 3M transparent tape and invisible tape that is pending in a federal
court in Pennsylvania that was disclosed in our 2005 10K. And finally, we may incur
restructuring charges or other expenses in connection with our pharmaceuticals business.
In that these items are not currently estimable, they are not in our second-quarter or full
So, before we begin the question and answer, let me summarize our results. This was
another outstanding quarter for 3M, characterized by broad-based growth from our entire
portfolio and continued strong leverage to the bottom line. Quarterly sales reached an all-
time high with local-currency growth of over 10 percent, and we delivered a double-digit
net income increase while also accelerating our investments in the future. We are off to a
very strong start in 2006, which gives me great confidence in the ability of our teams
around the world to drive accelerated growth and achieve superior financial results. In
fact, this confidence in our team is what led us to raise both our full-year growth and our
This concludes the formal part of today’s call so let’s now begin the Q&A.