3M Company (MMM) Q3 2008 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the 3M Third Quarter 2008 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. After which, you will be invited to participate in the question and answer session. [Operator Instructions]. As a reminder, this conference is being recorded, Tuesday, October 21, 2008. We would now like to turn the call over to 3M.

Good morning, this is Matt Ginter, Head of Investor Relations for 3M and I would like to welcome to all investors and analysts to our third quarter 2008 business review. As a quick reminder, please mark your calendars for the morning of December 8th. We will host a meeting in New York City, the primary purpose of which will be to discuss our 2009 business outlook. Stay tuned for full details and of course this event will be webcast. As always, please take a moment to read the forward-looking statements on slide 2. 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 forms 10-K and 10-Q lists some of the most important risk factors that could cause actual results to differ from our predictions. George Buckley, our CEO and Pat Campbell, our CFO will both be speaking today and then we will get to your questions. During Q&A, please limit yourself to one question and one follow up. We'd appreciate it. So now please go to slide number 3, and I'd like to turn the program over to Pat.

Good morning everyone and thank you for joining us this morning. All information that I will present today will exclude special items, so allow me to summarize our special items quickly to get them out of the way. Last year's third quarter results included a net gain of $0.03 per share from special items. GAAP reported earnings per share was $1.41, which included a net $0.01 per share charge in 2008. While I recognize this charge is small on a net basis, it is important that you understand the pieces. First, as disclosed in our first and second quarter 10-Qs, in March, we entered into a sale-leaseback agreement related to our existing outdated office building in Italy. This was a lucrative transaction for us as the real estate was in a very desirable location and allows us to reinvest in a new, very modern right sized facility over the next year. We recorded a $41 million gain in Q3 as a result of this transaction. This gain was more than offset by nearly $50 million of severance and exit activities in several of our businesses and corporate headquarters as we are aggressively balancing our business structure to a slower growth environment. Excluding these special items, Q3 2008 per share earnings were $1.42 as compared to $1.29 per share in last year's third quarter. Please refer to the attachment in today's press release for a complete discussion of special items. We delivered record third quarter sales and all-time quarterly records for both operating income and earnings per share in the third quarter even in an increasingly challenging and more uncertain global economy. Sales for the third quarter increased 6.2% to $6.6 billion as five of our six business segments posted positive sales growth, led by double-digit growth in Safety, Security and Protection, Health Care and Industrial and Transportation. On a local currency basis, sales were up 4.4% over the same period last year and were in line with sales growth trends for the first half of the year. Looking at the company geographically, third quarter sales growth was balanced across the globe with the U.S. growing 6.5% and International posting growth of 6%. International sales were led by double-digit increases in Latin America and in the Asia Pacific region excluding our Optical Systems business. Operating income increased almost 9% to more than $1.5 billion as all six segments posted greater than 20% operating margins and three segments saw double-digit, year-on-year operating income percent gains. In this environment, this is very good performance. Earnings per share in the third quarter was $1.42, up 10% year-on-year. Our third quarter performance reinforces the strength of our customer focused diversified businesses, technology platforms, unparalleled geographic reach and our relentless attention to operational excellence. These foundational pillars along with our balance sheet strength provide stability and consistency in an uncertain global economy. Please turn to slide 4 for an in-depth review of our third quarter P&L performance versus the same quarter last year. As in past quarters, we have isolated the impact of optical films in order to help you better understand our underlying results. The strength and consistency of our global portfolio continued to drive sales in the third quarter. Sales increased 6.2%, or nearly 10% excluding optical versus the same quarter last year. Gross margins increased 30 basis points due to a combination of selling price increases, foreign currency translation and a continuous focus on driving operational excellence, which more than offset raw material inflation of nearly 5%. This quarter, operating income was $1.5 billion, up 8.7% and almost 19% excluding optical. You may have noticed in the attachments to today's press release that our Corporate and Unallocated had operating income of $35 million this quarter. There are two primary reasons. First, we continue to reduce costs in our corporate overhead areas. Total Q3 overhead spending was down $33 million year-on-year, $15 million of which resulted in a gain in Corporate and Unallocated. This is consistent with the strategy that we have been driving for many years. Second, as we have discussed in past quarters, we are experiencing a reduction in pension expense in 2008 versus 2007 to the tune of approximately $24 million per quarter. Rather than allocate the benefit to all of our businesses, we elected to record this year-on-year improvement in Corporate and Unallocated. Operating income margins for the quarter were 23.2%, up 60 basis points versus last year. Net interest expense was $24 million, up $8 million year-on-year, primarily due to higher net debt balances. The tax rate for the third quarter was 32%, or 31.5% on a year-to-date basis, both of which are in line with our expectations. Earnings per share increased 10.1% to $1.42 or approximately 20% if you excluded optical. Please turn to slide number 5 where I will break down our third quarter sales growth performance. Worldwide sales grew 6.2% with the U.S. rising 6.5% and International up 6%. Third quarter local currency growth was 4.4% including 4% from acquisitions. Selling prices increased 60 basis points, which, if you exclude selling price reductions in our optical films business, would have more than offset material inflation in the third quarter. Organic volumes declined slightly in the quarter. Foreign currency added 2.1% to worldwide sales, which was less than one-half of the benefit that we saw in the second quarter. If you use the current exchange rates, we would expect the sales impact from foreign currency to be in the range of a negative 3% to 4% in the fourth quarter. Excluding optical, worldwide local currency sales increased 7.8% as organic volumes increased 1.6%, selling prices increased 1.8% and acquisitions added 4.4%. As mentioned, third quarter sales in the U.S. increased 6.5%, led by Safety, Security and Protection and Health Care. Four of our six business segments delivered positive sales growth in the quarter. We increased prices nearly 3% in Q3, which was needed to offset U.S. raw material inflation of just over 5%. Consistent with the first half of the year, organic volume growth in the third quarter continued to remain challenging in the U.S., declining 2.5%. We continue to find outstanding bolt-on acquisitions in the U.S., however, which are bolstering... helping to bolster many of our core businesses. In aggregate, acquisitions added 6.8% to U.S. growth. International sales on a local currency basis increased 2.7% in the third quarter. Organic volumes increased 1% with five of six businesses posting positive organic volume growth. The lone exception of course was Display and Graphics, which is living through the secular transition of optical films. Selling prices declined 70 basis points, but would have increased 110 basis points excluding anticipated price declines in Optical Systems. Acquisitions added 2.4% to international local currency growth for the quarter. Excluding optical, international local currency sales growth was 8.2% including 4.4% from organic volumes, 2.7% from acquisitions and, as mentioned, 1.1% from selling prices. Regionally speaking, local currency sales growth was led by Latin America at 18%, followed by Canada at 9% and Europe at 4%. Local currency sales declined 3% in Asia Pacific, heavily impacted by a 34% decline in optical. Excluding optical, Asia Pacific sales in local currency increased by more than 10% over the same quarter last year. We are facing, as you know [ph], challenges of slow U.S., West Europe and Japanese economies and are making disciplined decisions to maintain our focus on operational excellence and using our healthy balance sheet to become an even stronger company in the future. Before we move to the business segment highlights, please turn to slide 6. Here is a quick synopsis of our year-to-date progress. Through the first three quarters, year-to-date sales were up 8% with operating income up 7% and earnings per share up almost 11% to $4.19. Excluding optical, year-to-date sales were up 11.5% and profits increased a healthy 16.4%. And finally, year-to-date free cash flow was up 8% versus the prior year. All things considered, these are very good results under these economic conditions. Please turn to slide 7 for a review of the balance sheet and cash flow metrics for the third quarter. Free cash flow for the quarter was a strong $792 million, which included a $200 million U.S. pension contribution. Third quarter is typically when we make this contribution. We converted 80% of net income to free cash flow this quarter, or a full 100% if you adjust for the pension contribution. So cash flow remains very strong. Working capital remained stable at about five turns. Capital expenditures totaled $376 million, which was about flat year-on-year and up $42 million sequentially. We are on track to invest about $1.3 billion to $1.4 billion in 2008. Dividend payments for the quarter were $348 million and share repurchases totaled 515 million, both consistent with recent quarters. Weighted average shares outstanding were 703 million, down nearly 4% year-on-year and 1.3% sequentially. Please turn to slide 8. Given the credit markets turmoil, I thought it would be helpful to provide some more insight into our liquidity position at quarter end. The strength of our capital structure and consistency of our cash flows provide a real competitive advantage at times like this as they afford us stability when many of our competitors face uncertainties and constraints. They also allow us to continue to invest in our businesses, strengthening our competitiveness and aggressively pursuing new business, which is exactly what we are doing. During the recent dislocations in the financial markets, we have successfully issued commercial paper and in fact we have been able to place commercial paper with 2009 maturities since the end of September. We have achieved this at interest rates which we had seen well before the recent market malaise. We also raised $850 million via a long-term debt issue in August at a very attractive rate. So for now anyway, we have weathered the storms very safely. Our cash and debt position is displayed on the left hand side of this chart. At third quarter end, we had $3.6 billion of cash and marketable securities on hand. Short-term debt was $2.3 billion including $1.7 billion of outstanding commercial paper. Long-term debt was $4.8 billion. Debt maturities for the next five quarters are detailed in the middle of the slide. As you can see, $950 million of debt will mature through the end of 2009. This amount includes a $350 million dealer remarketable security classified as short-term debt that is due for remarketing in December of this year. The majority of our longer term debt balance of $4.8 billion does not mature until 2012 or later. So while credit markets remain volatile, our capital structure remains very strong and continues to differentiate us from weaker competitors. We will continue to manage this asset very carefully. Now let's turn briefly to an explanation of the performance for each of our segments in the third quarter. Please turn to slide 9 for a summary of our results for our largest segment, Industrial & Transportation. With broad-based revenue growth across the portfolio, Industrial and Transportation delivered an outstanding quarter with sales up 10% to almost $2 billion. Operating income rose 8% versus the same quarter last year. Sales growth was led by our industrial adhesives and tapes business, followed by our automotive aftermarket, abrasives and closure systems for personal hygiene products. Local currency sales increased 7.1%, including 4.2% from acquisitions. Year-to-date sales and profits were both up about 14% and operating margins held steady at 21.2% for the year. All geographic regions drove sales growth in the quarter, led by double-digit growth in Asia Pacific and Latin America. And even in this tough U.S. economy, we managed to generate positive sales growth in the U.S. We continue to drive strong market penetration in emerging economies, especially the high growth BRICP countries where the business drove strong double-digit local currency growth. Now please turn to slide 10 for a look at the third quarter highlights for our Health Care business. This is an absolutely fabulous and underappreciated part of the 3M portfolio where we provide the healthcare community with technology-driven innovative solutions to improve patient lives and the productivity of healthcare providers. Health Care drove strong sales growth of 10.7%. All major businesses within Health Care drove positive growth in the quarter, led by oral care and medical. Local currency growth was 9.2% with 2.7% coming from acquisitions. Profits in the quarter rose 17.2% to $304 million. Our Health Care team drove double-digit growth in Asia Pacific and Latin America and mid single-digit sales growth in both the U.S. and Europe. No doubt this was another fine quarter for the global Health Care business. Year-to-date, sales have increased 11.9%, profits have risen 16.1% and margins improved by a full point from 2007 levels to 28.7%. Please turn to slide 11 for a recap of our fastest growing segment, Safety, Security and Protection Services. Sales in this business rose an outstanding 27% in the third quarter to $1 billion. Our recent acquisition of Aearo Technologies contributed 19 points of growth in the quarter. Aearo is a great fit with 3M as it broadens our personal safety product offerings in a market that we know very well. And thus far it has proven to be everything we thought it was and even more. Organic sales was an impressive 9%, led by growth in personal protection solutions, protective window films, and cleaning solutions for commercial buildings. Operating income for the quarter rose 42% while margins increased 2.3 points year-on-year to 22.8%. Year-to-date, sales have increased 23.7% with profits up 27.3% and margins holding steady above 22%. Sales were strong across the globe, led by double-digit sales increases in the U.S. and Asia Pacific. Profits rose at double-digit rates in geographic regions to round out another outstanding quarter for this business. Now please turn to slide 12 for details about our Consumer and Office business, home to some of our best-known category defining brands and enduring franchises. Consumer and Office sales increased 5.2% to $946 million in the third quarter. Local currency sales were up 3.7% with 0.5% from acquisitions. Profits were up 12.7% with operating income margins of 22.9%. Year-to-date sales and profits were up 5% year-on-year, which we feel is an outstanding result in the current business climate. In the third quarter, we drove positive growth in all divisions with home care and do-it-yourself leading the way. We drove 2 points of sales growth in the U.S. this quarter, which is impressive considering the state of the U.S. consumer and retailers. Our international subsidiaries continued to drive growth again this quarter with double-digit sales increases in Latin America and Asia Pacific. Please turn to slide 13 for a review of our third quarter results for Display and Graphics. As you well know, our results in this business have been impacted in 2008 by our optical systems business, which is in the midst of a transition from a hyper-growth business to a more commoditized business. The good news here is that the LCD TV business appears to have stabilized sequentially and is now running in line with our expectations. Forecasting LCD films is no walk in the park by any means, but predictability has improved immensely and the operating team is really driving to get their arms around the business and drive costs out at levels we've never seen before. We posted sales of $853 million in Display and Graphics in the third quarter. Sales declined 16%, but were up 2% excluding optical. We drove positive sales growth in both Traffic Safety and Systems and Commercial Graphics. Optical Systems declined 34% year-on-year, but improved by 5% sequentially. Operating margins were down year-on-year, but it was encouraging that we held constantly... constant sequentially at 21.2%. On the new product front, 3M's MPRO 110, an ultra compact, LED-based projection engine for business and entertainment use is now in production with sales beginning in October. I will wrap up my comments on slide 14 where I'll provide a brief overview of results for our Electro and Communications business. Sales for the quarter increased nearly 3% versus the same quarter last year. Profits rose 7.5%, driven by outstanding cost discipline, producing margins of 21.4%. Sales in local currency increased slightly. Our Electro and Communications team drove double-digit growth in two of its businesses, namely Electrical Markets and Electronic Markets and Materials. Geographically speaking, growth was led by our international operations in Asia Pacific and Latin America. Year-to-date performance in Electro and Communications has been outstanding with sales up nearly 7% and profits up 11%. Year-to-date margins have improved 80 basis points to 20.6%. That concludes my formal comments this morning. So now, I will turn the program over to George. George?

Thank you very much Pat and good morning again everybody to our third quarter call. As it turns out, our earnings were well ahead of expectations and delivered operating EPS of $1.42 despite a significant reversal of currency and softer demand in some sectors and locations. The global financial crisis, which happened right towards the end of the quarter, caused a number of last minute cancelled orders from distributors and retailers in their own understandable just in case attempts to preserve cash. But for that, earnings would have been even a little bit better. An obvious reality of being a short cycle company is that we see the effect of demand reductions more or less immediately right across 3M's product portfolio. We live right on the edge of that razorblade. When they are just temporary blips rather than trends, they also pass through the system quickly. 3M is a company that can be impacted by downturns quickly, but it's also one which usually recovers quickly also. Housing and consumer durables have come to the forefront of people's minds again. I must say, though, that because of the nature of our business, apart from the financial crisis, there is really little new market news in this for us, or in what's going on in the broader world economy today. We've been experiencing and dealing with the impacts of a slow U.S. housing market, a tough retail environment, a slow U.S. automotive market and softer industrial manufacturing for a long time, about two years in fact. When you add to this the impact of the reinvestment burden we carried and the commoditization taking place in the LCD TV market, it has been a very challenging operating environment for us and one which I think has been well handled by 3M's management team. As you know, at the beginning of 2006, we began to vigorously rebuild 3M's core. We added manufacturing capacity that we needed, we in-sourced core products that had been outsourced and were creating competitors, we invested a lot more on R&D and in new products and we reopened our adhesives research lab that had been closed in 2002. We used acquisitions to help us speed up the rebuilding process. After three years of doing this, the rebuild is now mostly completed. We are now gaining share in every one of our core businesses, margins have remained at their previous levels and despite some pressure from a weakening dollar in '08, returns have stayed in premium territory. I tell you this story only to drive home the point that the innate underlying strength of 3M has improved dramatically in the past three years. This is not your father's Oldsmobile, as they used to say. We have some excellent competitors whom we have a great deal of respect for. But we are now making them feel 3M's competitive presence everywhere and I can assure you we intend to do that continuously. We now have the strength and products to do it. It is this fact that is going to equip us well to deal with some circumstances that are likely to be even tougher in 2009. Like everyone else who consolidates in the U.S., we had some welcome help from currency. But it has been just rebuilding of 3M's core which has allowed us to perform consistently well even with the gale force economic headwinds and a commoditizing TV business. I want you again to look at the sales and earnings numbers that Pat showed you with and without optical. That clearly shows you the power of 3M's wonderful core businesses and I think the importance of that great base will ultimately be recognized one day. I will continue to say this while there is breath in my body, but the diversity of 3M and its geographic spread are what allows us to put in this kind of performance in this kind of time. Take a look at the Consumer and Office results also please. They delivered 2% organic growth in the U.S. at a time when every normal expectation for them would be negative. This doesn't happen by accident; it comes from a string of innovative new products that they've released and industry leading customer service. As Pat outlined, the same is true almost all across 3M, the only tight spot being Display and Graphics. Their numbers were heavily colored by the LCD TV commoditization and slow traffic sign sales because of the delayed Highway Bill. But I think our numbers again show the merit of investing in our great core franchises right across the board. Despite having done well in the face of some pretty tough challenges, we are far from feeling complacent about what lies ahead. This is going to be a tough period for everyone. But we aren't scared of it either. This is what we are paid to do: operate well in a range of environments. So the $64,000 question is this: what can we sensibly say about the future and what are we doing to prepare for it? On the first question, you know we don't give quarterly guidance except de facto for the fourth quarter. The challenge now is to give you a plausible forecast for Q4 at a time when volatility makes the future almost impossible to predict with any degree of precision. So I am not going to give you any sales projections for Q4. But operating margins came in strong again in Q3 and we believe year-over-year margins will hold reasonably steady in Q4 and even going on into 2009. Given that we are always affected quickly by the economy, the quality of our Q4 earnings will no doubt be colored by the strength of the Christmas season and on currency and the impact of tight credit on various end markets. But I don't think Christmas will get canceled this year even if it turns out a little more muted than normal. The economic turmoil and skittish customer environment suggests there is more downside risk for now than there is upside opportunity. But I don't expect this to be large. We are not immune from the economic pressure, but I also think 3M will show a lot of economic resilience and will gain share during this time. We are still expecting to grow EPS in the range 8.5% to 10% for 2008. Specifically, we think earnings will be in the band of $5.40 to $5.48 for Q4, assuming exchange rates remain around where they were today. We will give you a more in-depth view of 2009 in December as Matt already mentioned. Apart from the obvious worries about the U.S., the biggest headwinds that we see for now are a reversal of currency gains and slowing economies in Western Europe, Canada and Japan. Absent optical, Asia remains reasonably strong for now as does Latin America, the Middle East and Eastern Europe. Cost pressures on commodities have eased somewhat and, with varying degrees of success, we are clawing back prices that were oil or commodity based. To the second point, how we are preparing? In fact, we've been preparing and taking action for some time. We've been working to get well ahead of the cost curve and have eliminated about 1000 positions spanning the U.S., Europe and Asia with Asian reductions being heavily focused on optical. And we will continue with similar productivity improvements in Q4 as we continue to work to stay ahead of a bumpy business environment. So for now, we continue to operate our company very tightly and here are some of the things we are doing. We are in cash preservation and build mode and not in the market for... so [ph] in any meaningful way. We have slowed capital expenditures, stopped all hiring in the U.S., Canada, Japan and Western Europe except for replacing key sales and production positions. We have also embargoed U.S. acquisitions for the time being until we see how the end markets play out. We are closely watching receivables for the negative trends; none so far I might add, and we have already reduced our capital budget for 2009 by about $200 million. Inventory will also be a focus. We will do more in all these cases, if circumstances require it. All discretionary spending has been put on hold; though, we have opted not to slow R&D expenditure. That is our company's future and we want to make sure it's there when we need it. Prudence and careful tendering of our company's economic garden has always been the order of the day here and it will remain so. That said, this is not the time to play figurative corporate tortoise, in any sense of the word. By that, I mean being slow moving or pulling our heads back inside our shells. This is the time to be vigorously working with our customers and moving fast to capture as much business as we can. We are going to do everything we sensibly can to get sales and continue to win share, operate excellently and manage our cash well. Trouble is not the only thing born in these times; opportunity is born also, especially for strong companies who can use it as a platform to grow stronger. We have planned for that and intend to take any sensible opportunities for growth that we can. Chance always favors the prepared mind. With that, I'd like to turn the call over to your questions. Thank you very much for listening. Question And Answer

[Operator Instructions]. Our first question comes from the line of Scott Davis with Morgan Stanley. Please proceed with your question.

Good morning guys.

Good morning.

I applaud the actions... restructuring actions. What was not entirely clear in your comments George is that the guidance for 4Q looks a little bit lighter than what we had in our models. And is that an indication that you're being extra conservative given the macro or has October really... you said September finished off a little weak. Did that continue into October, which is driving your conservativeness right now?

Scott, it was weak at the end of Q3. We saw it as kind of a temporary blend. Orders popped back in the early part of the quarter, but then perhaps a little softer than we would hope. So we're being a little cautious here. I think it's a prudent thing to do in this time. There is no medals for any heroes at this time. So we're taking a very prudent view I think of what's likely to happen in the fourth quarter.

Hey Scott, Pat here. The other thing that has kind of changed quite a bit of course is exchange rates. Exchange rates have moved quite a bit from last time we talked to you, even really since the end of the quarter here. So if the exchange rates stayed where they are at, specifically thinking more the dollar-euro combination and some of the other currencies that have weakened quite a bit, that's kind of what has impacted our thinking for the fourth quarter.

Right. Just to dig in a little bit to your organic volumes and your price changes in the quarter, pricing up 2.9% in the U.S., but down 0.7 in international. I assume that's because of optical, but maybe you could put some clarity behind that and then same with organic volumes down 2.5%, but up 1% international. It's a real slowdown international obviously, but still positive. Just a little bit surprised you are able to get such good... but I guess my question is your prices are going up in the U.S. and volumes are going down. Was it the price actions that drove the weak volumes in the U.S.? And am I correct to assume that the weaker pricing international was optical?

I guess kind of deal with it a little bit reverse. The optical, the answer is right, will be positive price excluding optical on the international side. So it was heavily impacted by optical. On the U.S. side, we don't believe at this point in time that our pricing actions have materially affected our volume performance in the marketplace. We think the strength of our products and brands in the marketplace gives us the opportunity to price. It's obviously something you prefer not to have to do for a customer, or a customer's sake, but with the raw material situation the way it is, we really had no other choice.

And then, just lastly, Health Care margins have been just great all year and growth also. Is there anything... I know you don't want to give '09 guidance per se, but is there anything that would lead us to believe that that would slow down in '09? I mean was there a flurry of new product introduction or something that really drove that growth in '08 that may not repeat in '09?

No, I don't know there is anything that is unique, Scott, in Health Care. We have a fantastic healthcare business. I think if you lined our healthcare business up against any other healthcare company out there, you would see that our positions in the marketplace are in the top two or three spots in many cases. And the margins really are a sustainable position. A lot of it's about leveraging the strength of the whole company is the reason those margins can stay there. And we're already most innovative product company in most of those healthcare categories which provides room for price as well as our product positioning as well.

Super. Thanks guys.

Thanks Scott.

Our next question comes from the line of Jeff Sprague with Citi Investment Research. Please proceed with your question.

Thank you very much. George, for starters, could you give us a little color. It sounded like the BRICPs were in fact pretty decent in Q3. But is there some signs that kind of the leading edge of some of the short cycle businesses in those end markets are starting to soften up also?

No Jeff, not really. You could pick on any one market, any one country and express some concerns about it. But broadly speaking, the BRICP countries remain solid as does Middle East, as does Latin America more generally and even China remains strong. There has been just one or two points erosion of growth in China, but generally speaking, those countries where you'd expect growth, Jeff, are good. And that of course is the place that we want to make sure that we continue to invest next year. It would be easy to sort of pull back in those places where we can accelerate growth. And I think the temptation across this is to avoid that.

Great. And then just a question for Pat on the liquidity. George actually mentioned an embargo on U.S. deals and no share repurchase. I mean obviously you need cash for the U.S. deals and U.S. share repurchases. So you look real liquid, but I guess the question is, is most the cash offshore and what is your flexibility to bring it back home if you'd want to?

WellJeff, I think as in the past, most of our reported cash does remain outside of the U.S. We did do a... the bond offering here in August, which gave us some cash here in the U.S. So we actually have a little more cash sitting in the U.S. than we normally have at the end of a quarter. But I think you understand the dynamics pretty well is that we are... our cash in the U.S. we usually for dividend repurchase as well as on CapEx and acquisitions. And to the degree when you bring cash back internationally, we do do that. We do repatriate a fair amount of cash every year. And of course at the end of the day it ends up being an economic choice. We probably have right now, I guess would be fair to say, probably about $3 billion of cash outside the U.S., probably $2.8 billion I guess is probably the more appropriate number. We can probably bring a billion of that or so back in a reasonable timeframe; the other requires a little more planning.

Great. And if I could just sneak one more in. Pat, can you give us any early read on how to think about pension for '09, whether you make more '08 contributions as you exit the year, or just some early thoughts on kind of the sensitivity around returns and where discount rates are and things like that?

Well, Jeff, I think it's a fair, fair question with the state of the markets. We were fully funded in our U.S. plan going into the year as we took a look at it at the end of the third quarter depending upon your set of assumptions. We think we're still in reasonably good shape from a funding standpoint in the plan. We'll continue to assess the performance here through the end of the quarter and obviously make decisions based upon where we see a BRIC [ph]. Kind of the tradeoffs is right now of course most people's asset returns are below water, especially against any assumptions they would have made. But on the flipside, the interest rate market, especially in today's credit market, actually has a tendency to increase your discount rate. So when you look at it on a kind of a funding standpoint, we're really not in that bad a shape as we stand today.

All right. Thanks.

Our next question comes from the line of Deane Dray with Goldman Sachs. Please proceed with your question.

Thank you. Good morning.

Good morning, Deane.

If I could also ask a question on the liquidities update, and that was a terrific slide in terms of showing the position. And Pat the best indicator there to us was that you were issuing CP with a 2009 maturity. So can you give us a sense of what the average maturity has been in the commercial paper?

I'm going to turn it... Janet Yeomans is our Treasurer. I'll just ask Janet to kind of respond to that question, Deane.

Right. Deane, that varies over time. But what I will say is that in the last couple of weeks, we found the markets much more conducive to business as usual. So it's been with that in mind that we've been showing paper out into 2009 at what we consider to be very advantageous rates. And we've had an increasing interest in people buying that paper. So at this point, we're feeling very, very comfortable about being able to access the commercial paper market. So no significant change to any of our profiles there.

Great, thanks Janet. And then on the consumer and office side, versus expectations, that was a positive surprise this quarter. Can you take us through some of the dynamics, how much of it was back-to-school, better, was it new products driven? But just take us through those details if you could.

Yes, Deane. I think the simple answer to the question is that's really the new products and the relationships that we have with the key accounts in the U.S. that are driving our additional business in the U.S. I would say that back-to-school was not better than it has been. So it's not a back-to-school rush by any sense. It's really around a better flow... continuous flow of new products, including what we brought up last quarter was our Filtrete program continues to expand. We actually had a very good program with Command Adhesive [ph] this quarter in the construction home improvement business. So it's really across the board. We had good scaling products sales and so forth. So it's really across the board. And as you expect, the one business have probably is a little more impacted right now would be more on the office product side. But the flow of new products continues in that business and we continue to stay ahead of the pack.

And Deane, another piece of this is along with that, along with what Pat said, we've won a lot of new planogram... a lot of new shelf space. Some of the programs like the Filtrete program that Pat mentioned are continuing to gather momentum. The end customers are seeing the value of the product and of course our products are very successful for the retailers, so they like to sell them. They're attractive. We've been in good industrial design, we are always trying to add new technology and new features for the product. And perhaps, this was one of those cases where quality is the right mission. In the words of my old grandmother. I think we all had grandmothers that said this [indiscernible]. So people are buying, people are buying quality, buying things that they trust.

Deane, this is Matt. The last thing I would add would be service. In terms of service to the customer, this is one of the strongest areas of the company as you could imagine given the very demanding customer base. But we serve them very well, are on time and full rates are... is high in this business as they already one of the company and that's very, very important to these particular customers. So when they want the product they get it, that's important part of the equation.

Thank you.

Thanks Dave.

Our next question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your question.

Good morning. It's actually Jason Minor [ph] speaking for David.

Good morning.

Hi there. Industrial and transportation, solid performance, but the sequential declines surprised us a little bit. So I wonder, George, if you could maybe illuminate for us some of the underlying details of what might be happening there, driving a little... maybe a decline in trajectory of growth.

WellI don't know that there's anything to be concerned about in this business at all. Obviously, U.S. automotive has slowed. But I don't think there's anything to apologize for these results. And a lot of good work going on behind the scenes to drive growth here further into new markets such as alternative energy. So I don't think there's anything to... for you to be concerned about in these numbers. Pat, you want to add anything?

Jason, I would echo the same thing. There really isn't anything that I would call material. You look at FX rates have kind of weakened a little bit. So if you look at top line reported numbers, that may be getting in the way a little bit, Jason. But if you look at the underlying growth rates in that business, nothing to worry about from our side.

And of course, Jason, the margins sequentially were spot on, so.

Okay, that's helpful. I just wanted to go back to George, your comments on CapEx.

Yes.

I know you said the transformation is largely complete, but we have been looking forward to some possible benefits from supply chain improvements. And just if we are having to pull back, I wonder if there is any of that at risk or if you could kind of outline what we have to tighten our belts on.

Well, there is always, in companies like ours, there is always a great appetite for capital. Obviously, more things you can do. So it's a question of prioritizing properly. We will continue to fix the balance of the supply chains that the most important that carry the high volume. And we've probably in some cases where we might have been a bit more optimistic about volume, we'll dial back on those things until we see where obviously these economies lie. But I am actually pretty pleased with the way that whole program has gone; in reality, it's probably going to be incremental additions in that program for the next two or three years, yet until we got the whole program done. If the whole program's ever done, if you get... if you continue to get growth, there's always going to be capacity you need to add. So I'm pretty pleased with the way that has gone. There is a sort of an invisible piece in this Jason, which is what's been going on inside the United States. People have homed in on the plant construction because a lot of supply chains have been straightening out inside the United States. So it will eventually as time goes on will deliver some working capital and cost improvements for us. So I'm not looking at the moment for any sort of great economy program. I think it's just prudent watching of the numbers, a little bit of tweaking and dialing back here and there, but no great crisis.

Excellent, that's very helpful. I'm going to try and sneak one more into. I can't let optical films go unmentioned. And I'm just wondering if we've talked about that the transformational year, if market conditions are making you suspect that the transition lasts a little longer, or how the shape of the plateauing, if you will, looks into Q4 and Q1. Thank you.

Yes, we forecasted at the beginning of the year that the vast majority of the transition was going to be completed in 2008. And there's nothing there that... nothing... there's no new news that we've seen. It could bleed over as we said. In earlier calls into the first quarter, I think there's likely a little bit of that possible. But absent the end market contraction, I'm talking about now, we'll... where the markets continue to soften a little bit. Absent that, we're doing very well. It seems that attachment rates have stabilized and it also seems that here and there, there's quite a bit more interest now in the energy play using films as a means of reducing energy by, in some cases, 50%. So that's a possibility for growth in the future. But we don't want to celebrate that right now. It's too early to celebrate any victories on that. But we're pleased that the trends are headed in the right direction.

Very helpful, thank you.

Our next question comes from the line of Shannon O'Callaghan with Barclays Capital. Please proceed with your question.

Good morning guys.

Good morning Shannon.

Good morning.

Aquestion on price. It's been ramping up here. It was a strong contributor in the quarter. Pat, you mentioned the raw material pressures that have contributed to that. With raws coming down sharply and economy slowing, it seems reasonable that's not going to be the contributor it was this quarter. I mean, is that the way you look at it or do you think it's still going to be a positive contributor for you guys?

Well, Shannon, it will continue to be a contributor on a carry over basis. So, the prices that we increased in the marketplace, we planned all those, so they will continue on for a period. We'll of course monitor the material position, not all raw materials have necessarily come down inline was some of the underlying commodities so we have keep a very close eye on that, so it's a balancing act and we're trying to manage obviously our growth rate and profitability at same time in places and element of that.

Are you hearing your customers push back and you'd all yet?

Customers push back all the time, let's say its kind of a...

Specifically on the raw and P&L given the headline raw numbers coming down I mean have you heard that comment coming back yet?

Well of course we do, we've got all the time and then conditions like this you would expect to have it. And this is where I think having a strong product, strong brands, strong relationships really carry the day. So we'll... I'm not worried about that.

Okay. And how should we think about this R&D percent of sales I mean it was down last quarter down again in this quarter, and George you mentioned not wanting to fill R&D and that's one of the things you're going to stay committed through the cycle. And so if we could think about a dollar amount here more than a percentage of sales or is that kind of there as a percentage of sales going forward kind of I went through this a little at the Investor Day but its picked down again here this quarter?

Yes Shannon, we don't manage to a particular percent of sales is not that for the targets been in that area. And not always spend as in people, there are sort of lumpy spends quarter-to-quarter in equipment we buy, in small investments we made that we take to expense and so, again there is not story to be seen already in to that trend. We still remain committed to use R&D as a sort of aggressive competitive weapon. And so I don't think you should draw too many conclusions from that sequence of numbers.

Shannon, the other thing that you'll run into is that depending upon the mix of business in any given quarter, and I think about this quarter as an example. Consumer is heavier in the third quarter, their R&D spending is lower... it was lower than the average. So you get some mix effects as well on a quarter-over-quarter basis. So that's why we don't get concerned about the consolidated number. We look at it business-by-business.

Okay. Thanks guys.

Thanks.

Our next question comes from the line of Steve Tusa with J.P. Morgan. Please proceed with you question.

Hi, good morning.

Good morning, Steve.

Good morning, Steve.

So you gave us a little bit color on the ForEx impact in the fourth quarter on the sales line. What would that be? How does that translate to the bottom line on an EPS basis?

Well for the fourth quarter, the numbers today Steve would imply probably about $0.10 hit in the fourth quarter from what we previously were thinking going... if you would kind of go back to last call and so fourth. So that's about the impact that it's going to have on us.

So that's a swing from I guess a modestly positive to a negative 3% to 4%.

Probably on an EPS basis slightly negative in the fourth quarter.

And does that change... does that kind of I guess margin on ForEx change at all into next year, or is that kind of the way we should think about it as we look at the negative ForEx comps as we think about '09? That's not really '09 guidance, that's just the way your... the model works there.

It will obviously carry into the '09 expectations and we'll give you some more color on that when we meet here in December.

Okay, great. And then one last question just on the fourth quarter. To get to your operating margin target, you're going to need a pretty good fourth quarter margin number. And since you really aren't giving us sales guidance, how can you be so confident in that margin when I guess you're not confident enough to give us a volume target?

Well I think a little bit, Steve, it's kind of our historical operating performance that gives me the confidence we can run in that range. The other day, we try to balance the top line, bottom line, a mix of the company. The wildcard as we just kind of talked about a little bit is the foreign exchange side. But... so I guess I'm not overly concerned about a specific number at 22.5 for the year. It obviously implies that the fourth quarter will be below that, so.

Right. But I mean you did 20.8 in the fourth quarter last year, and maybe I'm just not remembering some negative issues in the last quarter, the last year's fourth quarter. I'm just curious, is there something outside of sales that we should be thinking about? Maybe you guys have a little more costs that you've taken out or something that contributes to that sound fourth quarter. Somewhat important as far as our thinking into next year in a weak volume environment.

Yes, I guess... thanks Steve. I guess what we're implying is that on a year-over-year basis, we probably will end up with a slight margin improvement. So think of it as probably being more costs oriented. We talked about the severance actions that we've been taking in Q2, Q3, likely here in Q4. So we are definitely squeezing on the costs side to make sure that we can deliver the earnings to you.

Is that something that's sustainable into next year?

Definitely. It probably will have to be more.

Okay. Great, thanks a lot. [Call ends abruptly] .