3M Company (MMM) Q3 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the 3M Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, October 25, 2011. I would now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.

Good morning, everyone, and welcome to our third quarter earnings conference call. Before we begin, I've got 2 items just to mention. First, please plan to attend our Annual Outlook Meeting scheduled for the morning of Tuesday, December 6 at the Grand Hyatt Hotel in New York City. An invitation will go out today. Second, we will announce fourth quarter earnings on January 26, so please mark your calendars. Today, we'll discuss our third quarter results, along with an updated outlook for the remainder of this year. The slide presentation and audio replay will be archived on our website for an extended period. With me today are George Buckley, 3M Chairman, President and Chief Executive Officer; Inge Thulin, Chief Operation Officer; and David Meline, Chief Financial Officer. 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 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 lists some of the most important risk factors that could cause actual results to differ from our predictions. So with that, I will turn the program over to George.

Hi. Good morning, everybody, and welcome. Well, today, David Inge will lead the majority of the formal pieces of the call, but by way of a setup, I'd like to offer a few words at the beginning of the call. The quarter turned out to be very different one than what we expected. The challenges that we faced were primarily 2 causes and 2 effects focus. Cause #1 was words about European sovereign debt and the European economy. Cause #2, was the rapid contraction of the electronics end markets. It began with TV, extended to all the consumer devices and has now crept a bit into factory automation. Effect #1 was a flip in exchange rates as confidence in Europe's ability or willingness to deal with the crisis fell and its economy responded negatively. Foreign-exchange alone will reduce our earnings by up to $0.07 over the balance of Q4. This is the reverse side of having almost 70% U.S. sales outside of the United States. On the second effect, this was simply volume and the under absorption that comes along with it. In the last few months, worldwide IPI forecast for 2011 have fallen by 4,200 basis points. This a reset down in expectations of the global economy. Those who know our company well know 2 things always happen in these circumstances. First, that change is always amplified in the supply chain, temporarily suppressing net growth. And second, we always see the effect early, typically 1 to 2 quarters before our industrial peers. Without these factors or transients, our underlying organic growth would have been almost 6%, so underlying fundamentals are okay. The best in news is this: Electronics markets always recover quickly and early from these types of slash contractions, as do we. With that introduction, I'd like to turn the call over now to David to begin with the details. David?

Thanks, George, and good morning, everyone. Let's turn to Page #3. I'm going to start today with a few brief comments on the quarter, along with discussion of our current macro view, which has changed since the second quarter call. At the time of our July earnings call, the late quarter data was hinting that global economic growth was beginning to moderate. We felt it in our results and described it as such. But at that early point, it was difficult to ascertain the extent to which that softness might extend into Q3. Signs indicated this was temporary, and that better growth rates would resume in the second half of the year. Japan, of course, further clouded the picture. In this quarter's results, you will see that several of our businesses grew nicely. We posted worldwide sales of $7.5 billion, a 10% increase over last year's third quarter, and notably, a record for any third quarter in our history. 3 of our 6 businesses posted double-digit increases, namely Industrial and Transportation, Safety Security and Protection and Health Care and our Consumer business expanded their sales as well. Growth in these 4 segments was achieved through a combination of good organic volume, selling price increases and acquisitions, along with a dose of positive currency benefit. So while there is definitely growth to be had in this economy, certain segments clearly hit an inflection point in the quarter and some retreated. Western Europe is experiencing challenges given the uncertainty around fiscal and monetary policy direction. This is impacting consumer confidence and spreading to the manufacturing sector. Our organic volumes in Western Europe declined 4% in the third quarter after a flat results in the second quarter and a 4% increase in the first. The consumer electronics markets, excluding handhelds, slowed considerably as the third quarter progressed, which impacted our sales in Electro and Communications, and we also saw it creeping into factory automation too. We sell a broad array of component solutions to all types of electronic OEMs and roughly 1/2 of this business's sales go to the electronics industry. We know from history that electronic cycles are fast so volume declines are deep and short. But the good news is, is they also normalize quickly. In Display and Graphics, LCD TV remains the story, as OEMs are fighting a battle to lower prices, reduce inventories, and yet still create value for retail customers. By and large, with the exception of Consumer and Office and Health Care, we are a component supplier to our customers. Our products are generally consumed in our customer's manufacturing processes or embedded in the customer's end products. So our business is fairly short cycle. This means that when economic trends turn down, our customers alter production schedules and we feel the impact sooner than most. And those changes are nearly always accompanied by temporary inventory transients, which amplify the impact on our sales. Bear in mind this phenomena works in both directions. When the economy turns back up, volumes recover sooner and our growth is amplified as the channel fills again. We've been through these corrections many times in our past, and we know how to respond. Inge will speak more to this in a few minute moments. With that brief intro, I would like to now turn call over to Inge who will review the quarterly performance of our 6 business segments. Please turn to Slide #4.

Thank you, David, and good morning, everyone. While there is no doubt the environment is changing somewhat, there's a lot for us to feel good about in the third quarter. 5 of our 6 businesses achieved positive sales growth with 3 delivering double-digit growth and we posted an all-time record for third quarter sales. Now, let's take a closer look at each business, starting with Industrial and Transportation, our biggest business. Third quarter sales were up a solid 19% to $2.6 billion or 15% in local currency terms. Sales grew across all businesses, with double-digit increases in Abrasives, Renewable Energy, Aerospace and Industrial Adhesives and Tapes. Geographically, growth was broad-based, with sales up 28% in Asia Pacific, 22% in Europe, 15% in Latin America/Canada and 10% in the United States. Acquisitions contributed 6.8% to growth. Winterthur, one of our larger acquisition in this space, is a tremendous addition to our core Abrasives business. It is a technology-rich company in the area of bonded abrasives for hard to grind precision applications in industrial, automotive, aircraft and cutting tool markets. We have long admired Winterthur's technical capability, and we are very excited about the combination of our 2 companies. The integration is well underway and on track. Some of our businesses in Industrial and Transportation were affected by the slowing economic activity. For example, the Industrial Adhesives and Tapes business, which sells across most industries, including electronics, was particularly impacted. In our Industrial and Transportation business, profits grew by 21% to $525 million, with a high respectable operating margin of 20.4%. All in all, it was another solid performance for this business, which represent 1/3 of our global business mix. Let's move on to Health Care. Sales grew 14% to $1.2 billion or nearly 11% in local currency. The strongest growth came from our Infection Prevention business, which drove outstanding high single-digit organic growth in the quarter in addition to a nice boost from the recent acquisition. We acquired this company one year ago and so far, it has been a home run. Early indication saw that patient warming solutions for the operating room were catching on quickly in overseas markets where 3M has a strong presence in the hospital channel. Sales also grew nicely in our core Skin and Wound Care business and in Health Information Systems. Health Care sales increased a double-digit rate in every geographic region, with Asia Pacific up 20%, Latin America/Canada up 16%, Europe up 13% and the United States, up 12%. We have been investing more aggressively in emerging markets over the past couple of years to accelerate penetration in our Health Care platforms, and we are beginning to see the benefits in our results. Operating income in Health Care increased 13% to $367 million and margins were 29.5%. We are very excited about our new products in the health care space. For example, our Health Information Systems business recently developed and commercialized a breakthrough software that helps hospitals transition to new standard cooling system called ICD-10. We've already been selected by the Centers of Medicare and Medicaid services to support ICD-10 transition planning in its headquarters in Baltimore. Also, in our Food Safety business, we have launched a new test procedure in collaboration with a major food manufacturer to monitor shelf life and food quality. We achieved excellent sales growth in the Oral Care business, especially in developing economies. Recent acquisitions of both orthodontic companies in Brazil and China have expanded our presence in mid and lower tier categories, which will be critical to our long term success in these early stage, but fast growing markets. Let's now turn to Consumer and Office. Sales increased 7% year-on-year to $1.1 billion or 5% in local currencies. Operating income increased 4% to $244 million and margins were strong at 22.3%. Growth was broad-based in the quarter, with nearly all businesses growing in local currency. Notable performance were in our Consumer Health Care, do-it-yourself and Home Care businesses. On a geographic basis, sales grew in all regions, with particular strength in Asia Pacific at 18%, where we continue to invest in China and India to establish brand presence in these growing parts of the world. Latin America and Canada grew sales 11%, and Europe was up 5%, largely due to positive currency impacts. Sales in the United States were up 4%, a nice improvement year-on-year. Seasonal sales and new products helped drive growth in Consumer and Office. Back-to-school met our expectation and provided a nice lift in sales of our Command brand books and mounting solutions. We also expanded our family of market-leading filtrate products, with a new carbon-based home furnace filter that eliminates odor and allergens. On a global basis, we continue to gain penetration in the home care market, leveraging our leading Scotch-Brite brand. Overall, it was a good quarter for our Consumer and Office business. Now, let's go on to Safety and Security & Protection Service business. Sales rose by 18% to $954 million or 14% in local currency. Organic sales were up high single digits, and we added almost 6 points from acquisitions. All geographic regions posted positive growth, led by the United States at 28%, Asia Pacific at 25% and Latin America and Canada at 21%. Operating profit increased 23% to $202 million and operating margins were at 21.1% for the quarter. This quarter's strong growth was driven foremost by Personal Safety products, with good gains in both respiratory and hearing protection, 2 sites of sizable platforms within this business. We also saw a surge in sales from roofing granules, driven by last summer's heavy tornado season. That demand has worked its way through the channel and we anticipate some slowing in the fourth quarter. We drove double-digit growth in security systems accelerate by the December 2010 acquisitions of Cogent Technologies. Cogent gave us important technology in finger, palm, face and iris biometric systems to complement our existing border security and identification solution. Cogent also expands our reach into law enforcement, public safety and commercial access control applications. During the third quarter, we earned a nice win with the U.S. Customs and Border Protection agency, which is using 3M electronic passport readers in all the U.S. air, land and sea ports of entry. Let's now look at our Display and Graphics segment. Sales were $935 million, down 12% year-on-year and down 14% in local currency. As David mentioned, Optical Films for LCD TVs drove much of the decline. Retail TV demand continues to soften, therefore OEMs are lowering brightness specification in order to reduce prices. In addition, they are slowing production in order to lower inventories. On the positive side, we continue to see strong attachment rates on battery-powered devices such as tablet PCs, smartphones and notebooks, where the value proposition for our films is very strong. Excluding Optical, total Display and Graphics sales declined just under 1% in local currencies. Sales in Traffic Safety Systems declined a bit in local currency terms due to lower levels of highway construction funding by governments in the United States and West Europe. One of our newer businesses in this segment is Architectural Markets, formed a short time ago to accelerate our penetration in the design solution markets. Products here range from 3M Di-Noc finishes to advanced lighting solutions. This business posted double-digit local currency growth in the quarter and continued to show excellent potential. Finally, let's take a look at Electro and Communication business. Sales were $838 million, up 4% and profits were down just slightly to $181 million. Margins for the quarter were 21.6%. All geographic regions posted higher year-on-year growth, led by Europe and the United States at 7% each. Sales rose 9% in our Electrical Market business, a powerhouse franchise that serves the utility and infrastructure markets. Electrical is a true enduring franchise for 3M that just keeps on growing quarter in and quarter out. We also saw good growth in telecommunication markets in the quarter. Sales in the electronics industry rose just slightly, a considerable change versus the high growth rates we saw over the past several quarters. As David mentioned, this market has slowed, which significantly affected our customers' production schedules in Q3. This slowdown is expected to persist for the next few quarters. Electro and Communication announced a number of growth initiative recently, including an agreement with IBM to jointly develop new Adhesives to enable the creation of microprocessors that are up to 100 layers thick. These chips are potentially 1000x faster than those used today. We also announced a manufacturing capacity expansion for 3M ACCR high-capacity overhead conductors, which will gain traction in the marketplace on a global base. In addition, we are building new capacity for 3M branded Novec products used in electronics, data centers, semiconductors and medical markets. Please turn to Slide #5. As both George and David mentioned, it's clear that the macro trends have slowed and growth rates have drifted lower, which naturally begs the question how are we responding? First and foremost, we will stick to our long-term growth plan and continue to invest significantly in research and development. In fact, we have invested $1.2 billion year-to-date, up 14%. New product introduction will continue to fuel growth as we expand our businesses and drive market share gains. Experience tell us that it's especially important in this times to differentiate ourselves from the competition through great products. This is precisely how we improve our competitive position during the last downturn. Secondly, we remain bullish on our long-term growth in developing markets, and plan to continue investing in those countries. Emerging markets now represent 34% of the company, up from 17% in 2000. In addition, we are targeting $1.3 billion to $1.5 billion of CapEx in 2011 versus $1.1 billion in 2010, a healthy increase. We have good line of sight for future growth needs in all of our businesses, so this new capacity will be critical to our future success. We maintain a strong balance sheet, which enable us to return significant cash to shareholders through the ups and downs of economic cycles. Through 9 months of 2011, we returned $3.4 billion to shareholders via cash dividends and gross share buybacks. At the same time, we are establishing a 2012 plan with maximum flexibility. We expect the global economy will grow, but at slower rates, and anticipate there will be growth to capitalize on, but there will be bumps along the way. There just always are, and we all know it. We currently expect that the second half of 2012 will be better than the first as electronics will take a few quarters to wash through the system. Just as we did 2009, we will take full advantage of this time to engage with our customers to develop unique 3M solutions to their challenges. In terms of driving productivity, we have already been quite active during this year in a number of businesses. The Display and Graphics team, for example, has been reducing full-time and temporary position, primarily in Asia, to address declining factory utilization levels and put in place contingency plans early around spending. Electro and Communications responded to weakening demand with targeted action to improve productivity and reduce cost, while staying fully prepared to capitalize on eventual upswing. In Europe, our new regionalized subsidiary structure is driving speed and simplicity in our operation and will save us $10 million this year. Importantly, all of our businesses have aggressively prioritized and are prepared for whatever comes our way in 2012. Going forward, we have implemented hiring freezes in most developed countries. Replacement will be limited to those key positions that were closest to the customers. Our businesses have also triggered contingency plans with respect to indirect costs, which represent over $4 billion annually, so there's still room for more improvement. And finally, we are considering the need for more aggressive actions as we monitor economic growth in 2012. We will have more to say about 2012 at our meeting in New York City during the first week in December. Again, flexibility in our 2012 plan will be key. This quarter's slowdown could prove to be short and temporary, or it could linger into next year. We are prepared for either. So in short, our long term strategy is intact, our financial condition is strong and we are well-positioned to win in any economic scenario. That is a quick overview of the business result and operation. Now, we will turn the call over to David, who will provide some additional color on the quarter.

Thank you, Inge. Let's start with sales, so turn to Page #6. We posted a record third quarter sales of $7.5 billion, up nearly 10% year-on-year. In dollar terms, the growth was broad-based, with all geographic regions increasing year-on-year. Of note this quarter was Latin America/Canada region with 14% growth year-on-year. This was the eighth consecutive quarter of double-digit sales growth for the region. Currency was a net positive in Q3, adding 3.1% to sales. FX added 5% to sales in both Asia Pacific and Europe and 3% in Latin America/Canada. However, sales were impacted negatively by the late quarter surge in the dollar, which cost us over 1 point of sales growth. As I mentioned earlier, organic volume growth slowed in the quarter to 1.9%. Volumes increased in all geographic regions with the exception of Europe. More specifically, Western Europe experienced a 4% decline in organic volumes for the quarter. The 2 factors I mentioned earlier, namely the decline in Western Europe, along with slowing electronics, together, hurt 3M's overall organic volume for the quarter by nearly 4 percentage points. Normalized organic volume growth for the company, therefore, was closer to 6%. We continued to raise our selling prices in the quarter, a necessity in light of higher raw material costs. Prices rose nearly 1% year-on-year, adjusting for Optical, where price down is necessary in order to compete, prices for the company rose nearly 2% in the quarter. Through 9 months to date, all of our other businesses are now in a positive price position and are expected to more than cover raw material cost inflation for the calendar year cumulatively. Acquisitions added nearly 4% to sales in the quarter. Please turn to Slide #7 for a look at our income statement for the quarter. Sales, as I mentioned, rose 10% in the quarter, and gross profit dollars grew 6% year-on-year to $3.5 billion. Gross margins were 46.6% versus 47.9% in last year's comparable quarter. We were able to neutralize raw material inflation with selling price increases in the quarter, and we are on track to fully offset raw material inflation for the entire year, with the exception of Optical. As the quarter progressed, our sales did not develop as expected, particularly in September. Demand patterns were very good at times, but choppy during others. As Inge mentioned earlier, we took action to adjust our factory loading levels in some businesses, but the effects were not fully realized in the third quarter. The resulting under-absorbed overhead largely explains this quarter's gross margin decline. Helping to mitigate these factors are ongoing savings in our factories, including faster line speeds, waste reduction, yield improvements, energy savings and other ongoing productivity improvements, driven by our Lean Six Sigma teams around the world. SG&A rose 13% year-on-year, with 10 points of the increase coming from FX and acquisitions, underlying SG&A therefore rose 3%. Similarly, R&D investment rose 10% versus third quarter of last year, maintaining a healthy 5.2% of worldwide sales. 6 points of the R&D increase related to acquisitions and FX. Our business teams are working aggressively to achieve a 32% NPVI target for 2011, which would be an outstanding result considering a lower sales outlook. Operating income was $1.6 billion, up slightly year-on-year, and margins were 21%. Earnings for the quarter were $1.52 per share, down $0.01 versus last year's third quarter. The tax rate was 28.6% in the quarter versus 26.8% last year, which cost us $0.04 per share. A lower share count added $0.02 of benefit in the quarter. Please turn to Slide #8. Free cash flow for the quarter was $1 billion, and we converted 94% of net income to cash, consistent with our historical third quarter average. Networking capital impacts were slightly positive year-on-year, as both inventory and accounts receivable turns were right in line with third quarter 2010 levels. During the quarter, we contributed $248 million to our pension and OPEB plans, $55 million less than in last year's third quarter. At present, we are planning to contribute another $200 million to our plans in the fourth quarter, which would put the full year pension and OPEB investments at $600 million in total. Cash taxes paid were $43 million higher year-on-year. Investment in CapEx for the quarter was $336 million, up $108 million year-on-year. We anticipate full year capital expenditures of $1.3 billion to $1.5 billion, up from $1.1 billion in 2010. More than 1/2 of this investment will be in international locations supporting our ongoing strategy to localize production and better serve our customers around the world. Gross share repurchases in the third quarter totaled $849 million, putting us at $2.2 billion through 9 months of the year. For the full year, we now anticipate spending in the range of $2.5 billion to $3 billion, up from our prior range of $2 billion to $2.5 billion gross for the calendar year. Turning to Slide #9. With 3 quarters of the year behind us, let me address our updated outlook for the year. We now expect that earnings per share will fall within the band of $5.85 top $5.95 per share versus a prior expectation of $6.10 to $6.25. Organic volume growth will come in between 3% and 4% for the year versus a prior forecast of 6% to 7.5%, reflecting the more challenging economic environment we face. This is expected to reduce full year earnings by $0.25 to $0.30 per share. Partially offsetting this is the impact of a lower share count we have been more aggressive in purchasing our stock of late, which has the effect of boosting full year earnings by $0.04 to $0.06 per share. On the tax rate, we now estimate that our full year tax rate will be approximately 28.5% versus our previous projection of 29%. This equates to an additional $0.04 of earnings versus our July guidance. Finally, foreign currency impacts will be positive for the year; however, recent U.S. dollar strength has reduced the estimated benefit by $0.06 to $0.10 per share for the full year versus our prior forecast. Approximately 2/3 of this reduction can be attributed to the fourth quarter. Full year operating margins will be approximately 21% for the year. As a reminder, we are absorbing $0.22 per share, pension and OPEB expense headwinds in our 2011 results. Our new guidance suggested for this item implies year-over-year EPS growth of 8% to 10%. Lastly, I would like to share our early thoughts on next year's pension and postretirement expense. We are currently estimating a $0.10 per share headwind in 2012 related to pension and OPEB expense. This forecast assumes that the discount rate on our U.S. plans remains at 4.5%, which is equal to the rate at September month end. It also assumes U.S. asset returns of positive 6%, also equal to our actual performance for the first 9 months of the year. This wraps up our formal comments today. I look forward to seeing many of you at our meeting in December for a complete discussion of our 2012 plans. We hope you can make it. Now we will be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Laurence Alexander of Jefferies & Company.

On demand trends, can you give a little bit more detail on what you're expecting in terms of year-end shutdowns, and if any of the regional end markets where you've see a deceleration, you're already seeing signs of trends troughing?

Okay. Yes. On the first question concerning year-end shutdowns, what we see in particular is in the areas where we've seen weakening demands. So, for example, in the Optical systems division, we expect in the fourth quarter to have a continued weak demand in that area. And so, our factories supporting that activity will be running much lower than their full capacity, approaching the level that we experienced last year in the fourth quarter. If you look at D&G for the year, we, had last time indicated we thought Display and Graphics sales for the full year would be about flat. We're now expecting that to be in the low to -- in the mid to low single digits on a negative basis. If you look at the Electronics business in ECB, likewise, we're seeing reduced demand and declining requirements from a number of our customer areas, not only in consumer electronics, but also as we have mentioned, spilling over into some of the factory automation area. So we will have lower demand there, which will lower overall sales for that sector to the mid-single digits for the year. In terms of troughing, I would say we haven't really seen yet -- we don't expect to see an upturn yet. But what the indication is right now on October sales is that we're running pretty consistent with what we had had for the overall third quarter sales space.

Laurence, this is George here. This is, kind of, a little bit on to the backing to what David said. We typically see these things when they happen, if you sort of look at the cause and effect, if you go back to the numbers in IPI in the last couple of quarters, they've dropped by 2 full-percentage points, 200 basis points. What we always see is, that sort of amplified in our supply chain and then it bumps along the bottom, and for a couple of quarters, depending on the efficiency of the supply chain, clearing the excess inventory. And then it begins to creep back up. So we wouldn't expect to be seeing it just yet, but we would probably, if that model that we used in 2009, that seem to work so well there. If that continued, then you'd expect to see that, sort of, begin to sort of ease back up towards the end of the year or maybe into the first quarter next year. That's kind of what you'd expect from the demands that we've seen in the past.

Our next question comes from the line of Steve Tusa of JPMorgan.

I just have a question on the 100 bps of margin improvement for next year. Is that coming from the unusual factory loading, is some of that reversing in the fourth quarter? How visible is that margin improvement?

Yes, so obviously, we're still right in the middle of doing our '12 planning right now. But the way we're looking at this is, with the running rate where we expect sales to be more moderate next year -- sales growth to be moderate, what we're really looking at is rebalancing our plans so that we're going to run much tighter on the cost side through the year. And so we would expect that to show up -- that improvement to show up in combination between not only cost of goods, but a big piece of that we would expect to see in the SG&A area.

Okay. On the plant front, your CapEx went up pretty dramatically this year. Should we think about kind of CapEx being flat to down next year after this big bump up this year? How do you kind of manage your gross spending in -- from a capital perspective?

Yes. What I would say is that, exactly. We've seen an increase this year, which is being driven across the business as we localize our production around the world and respond to the fact that coming out of the last recession, we've run up against capacity limitations in a number of the areas. In the context of what we're looking at for next year and beyond, right now, we're not expecting a double-dip recession like the kind of recession we had in the last period. And therefore, we expect actually to see those capital expenditure demands to continue into 2012. So we don't see that right now backing off significantly at all.

Yes, Steve, we've never -- sorry, go ahead Steve.

Sorry. Go ahead. One last question, just -- I think we're back in the kind of flat to down organic for the fourth quarter. Can you just give us an idea of the segments and kind of the moving -- there's a lot moving around here, obviously, electronics, pretty weak. But the rest of businesses, holding up okay from a growth perspective. Could you may be give us an idea of how quickly some of the non-electronics businesses slow into the fourth quarter?

Sure. So in terms of by segments, the non-electronics businesses. So if I look at Consumer and Office and Health Care, we expect that the running rate on those, on an organic volume basis, will be similar to what we saw in Q4. So if you look at the full year sales for those businesses, we expect them to finish a full-year basis to be at the low end of the original guidance we'd given last year in December. If you look at ITB and SS&PS, in particular, we're seeing some softening in the third quarter. We expect the running rate in the fourth quarter to be similar to the third quarter rates, which would put those 2 businesses towards the low end of the range that we've set out last year for organic volume growth for those sectors, and the primary driver of that softening is what we saw in Europe in the quarter. So I think that's -- answers your question.

Steve, this is George. Let me just dip in one thing on the CapEx. Obviously, we allow CapEx plans and plant capacity in building over a period of many years. And our guys have not backed off their positive feelings about our growth prospects going forward. And about the many markets that we're managing to make great inroads into. So I think we wouldn't necessarily want to send any signals that we're suddenly giving up on the future just because these source of turbulent issues that you take in place partly in Europe and partly in the consumer electronics business. So we're just -- just want sort of reassure you that there is a pretty bright future out there and we expect to make it happen.

Our next question comes from the line of Deane Dray of Citi.

George, it's been a while since we've asked you to look into the crystal ball. You're really helpful in that -- at the early stages of 2008, but just give us your perspective. We heard from David give kind of 2 scenarios, it could be the shorter slowdown version or it could linger into 2012. And just from the basis of the de-stocking phenomenon, we've seen this before, but I never got the sense that there was a lot of restocking going on, so maybe that will help dampen it. But just kind of take us through your thinking about the scenarios from here.

Yes. Sure. I happen to have the unfortunate position, or joy, I'm not sure what it was, of forecasting that last sequencing and getting it right. And I think it was you that said I couldn't get out of the business until I got it wrong. So I hope I'm not going to get out of the business right now, but anyway, let me tell -- give an answer to your question. The modeling that I did actually back -- and it was a long time ago, almost in 2010, suggested that we would have -- I'm speaking here, Deane, about U.S. numbers. We can use U.S. as kind of a proxy for the world, but the U.S. would begin positive growth. It would peak -- that growth rate would peak somewhere around the middle of 2012. But the average over the half cycle would only be about 1.8% or 2%, and that's what that forecast suggested. So we're not actually expecting any kind of a big double-dip. In fact, I've called it internally a double dimple if you did -- it actually came, a little bit of a play on words I know. So I think we certainly see the reset -- we certainly see the worries I think, in the consumer markets. A lot of stuff driven of course by this European sovereign debt idea. But I think, probably, somewhat slower growth next year, Deane, for the United States. My personal guess is -- in fact the calculation says 1.8%, that I personally did for next year. So, you can take that as positive because it's -- at least the numbers are positive and it's not a sort of cataclysmic downturn. So, I think we'll see this kind of contraction. It will pass through the system. Those markets which are being affected, absent Europe, are pretty fast turnaround markets, Deane. So I think we're going to be okay for next year. I don't think -- absent some pension headwinds, I think, we'll see because of returns and discount rates. But above that, we feel quite confident we'll still have a decent year next year.

And your comment about the destocking might not being as severe?

Well, of course, we've made the calculations based on the same model we used in 2009. And they actually add up not too far off the numbers that we've seen, Deane, and you've got this aberration of Optical going out there, it's kind of muddying the water. But even if you did the quick calculations dropping from 5 to 3, we usually see that delta of 2, amplified by about 3, which will give you negative 1. At the growth that we're getting from NPVI, would put you back up in the mid-2s -- early 2s, and that's about what we see. So, it seems like the model still works as long as you don't try to put too much precision and accuracy into it, Deane. It seems to be working okay. And if it followed the same pattern in supply chain efficiency that we've seen before, the thing would begin to ease and in December, maybe early in the first quarter of 2012, recognizing of course, December itself is usually a pretty kind of meh month for most of us anyway, since there's not much activity. But generally, more cautious, but generally positive outlooks, Steve -- Deane.

And then last question for me, just on Slide 5, David referenced the ability to be more aggressive on restructuring, and we'd be interested in hearing, what are the trigger points that you're looking for in terms of when might you start doing that further cost-cutting?

Yes. So if you look at the comments that I think I made on that, right now, what we're looking at is, first of all, 3M's model, if you think about our business model, we're always in some kind of a change. I wouldn't call it a restructuring, but we're adding, we're trimming, we're moving people, we're redeploying assets. And so, that continues. So as Inge mentioned in the couple of the business, while we haven't talked a lot about headline restructuring, we've adjusted the manning levels, for example, in Mike's D&G business by 1,200 people in the last quarter. And we're adjusting in electronics, where we're also seeing the biggest effect. So we're making those changes as part of a normal course of the business. We continue to do that obviously in a weaker growth environment, overall, we're also making adjustments, but the $5.85 to $5.95 we have in the guidance now does not contemplate any type of additional special restructuring costs beyond the normal course that we're doing. And in terms of the planning for next year, frankly, we're going through that right now. As I said, as we looked at it, we were driving towards a point improvement for the business. That will involve taking a more cautious line in terms of how we're investing to grow, and that growth is going to be delayed. And eventually, we have to look at all of our businesses and make sure we're competitive. So we'll have to come out with more details here as we firm that up.

This is Inge. Just a comment, David comment on Display and Graphics and Electro and Communications. As you also see on the result, of course, West Europe -- and we have taken action there relatively early in the process. I think already 18 months ago was when we looked upon that organization and we did 2 things: We split off Central East Europe and Middle East Africa from West Europe. So we separate out our organization, and at the same time, we regionalized in West Europe. And that you saw the savings that we see there, around $10 million for this year. And -- so that have been to adjust the organization based on their situation in West Europe. So, I think that's an important thing for us to make sure that we optimize the structure, reduce the layer, go for more investment in the front-end and type of reduce in the back offices. And that's one of the things to where have gone in Europe and form those regions, where we today, rather than have 4 fully subsidiaries. In Nordic, we have -- now 1 Nordic organization. We have 1 organization in Benelux, rather than 2 subsidiaries. We have 1 region in Alpine versus 2 subsidiaries, so Switzerland and Austria, and we have also Iberia, which is a combination of Portugal and Spain. Although savings is helping us a lot and we're adjusting that as we go.

Our next question comes from the line of Steven Winoker of Sanford Bernstein.

Let me just start with the -- couple of follow-ups to the earlier questions. First 1, on that restructuring, how much restructuring is already built in for this year in terms of -- I know you're saying you're not doing it beyond what's normal, but what is the normal amount that's baked in?

We don't -- to be honest, Steve, we don't quantify in a specific way x amount of dollars in a quarter or a year because it's the normal course of the business that the guys run. So as I say, redeploying resources, re-purposing assets is normal of course. So I frankly wouldn't call out a particular dollar amount attributable to that.

Okay. That's fine. Just -- I often do hear that from some of the other companies, so that's why I'm trying to get at that. And on the CapEx side, how much of that is maintenance versus growth CapEx?

Hold on, I would -- well, let me talk about it trend wise. What we've seen this year, and if we look at the 2012 plans, there's definitely been a shift for us moving, obviously, more to the growth investments. So it's probably up, if I were to guess and Matt can confirm after the call, but it's probably up 10 points from something like 50% to 60% is what we would call growth CapEx in 2011. And we expect that to continue.

I think that it's in that neighborhood, Steve, but we'll follow up.

Steve, just let me say one other thing, which I hope will be helpful to you. Just -- remembering that we're investing to try to get a lot of the manufacturing capacity we currently have in the wrong places, in the right places. So there will always be an element of our CapEx spend, which is a little above, perhaps, what you might relate just to demand alone, so there's an element there. And so the patents that you see flowing from that are greater spend overseas, greater spend in markets which are growing very fast, energy conservation, and so on, and so forth. Some of which probably not may actually be resident here in the United States. And then last, but not least, one of the things that we decided we're really going to push on this coming year is to try to find a way to allocate an incremental cost, a piece of that capital to focus on driving gross margin, which is a supporting piece of the overall numbers that we're going to target for improvements next year. I would tell you that, while David is absolutely right, we haven't finalized these plans at all. We're still in that process. If you imagine, some elements of it had already been exposed, and we feel pretty confident, not just from a gross margin improvement location for efficiency and through automation, but actually in the overall cost reductions, we feel pretty confident we can get out those numbers or even better numbers. So it's well within our sights, it's well within our capability, and we'll give you some more details on that, Steve, in December, when we speak to you.

Okay. And just last question, on the op margin declines in Health Care of 30 basis points and Electro and Communications of 120, I noticed that volume price, together, were up 5.6% in Health Care and 90 basis points in Electro. So just maybe give us a sense for -- on the impact of, given that dynamic, what pricing was and what the investment level was, I know you have increased investments to some extent there. Just a little bit more clarity about why you had these going at opposite directions.

In terms of margins, see if I can respond, and if not, you can come back at me. Health Care, we did 29.5% in the quarter. As we've said before, we think that's the sweet spot for the business in terms of, on the high 20s. We are getting the kinds of price improvements that we've expected from the businesses. They're modest, because obviously, there's a lot of pressure, in particular in the mature markets, but we've been very encouraged here in Health Care through the year, we've seen increasing momentum for the business in the emerging markets as we've been investing to improve our position. So margins, we look at that, we think that for the foreseeable future is a good level from a planning perspective. In terms of ECB, we have not seen an overall price decline. Of course think about ECB as a combination of about half of the businesses is in the communications and in the electrical infrastructure space, and half is in the consumer electronics. So, a combination of those is, we're able to maintain price on an overall basis. And the key issue for us in terms of managing the price cost equation in consumer electronics, of course, is to continue to be specked into new products, to continue to innovate so that we can offer value to the customer and continue to get acceptable margins on the products. And I would say that's definitely true, despite this temporary correction that's taking place. We're very pleased with the momentum in the business in terms of achieving exactly that objective.

Additional comment on Health Care. I think if you -- as I made some comments in my opening remarks, we have accelerated our investment in emerging market for Health Care, and we now start to see the result in terms of penetration. Also, as we build out our capabilities around patient warming, that is going right into Infection Prevention based on the acquisition we made 1 year ago, that is also working very well for us. But there's some investment on that, which is mostly for additional investment into the international markets, where we happen to see opportunities.

Our next question comes from the line of John McNulty of Crédit Suisse.

This is Alina Khaykin sitting in for John. Just a few quick questions. One, on the raw materials. I know you said that you expect that the pricing that you put through so far will recover the raw material cost. But how much pricing do you think you'll have to give up, if any, when raw material costs do decline, say in 2012?

Alina, this is George. Historically, that's not happened. I think, perhaps -- we suffered a little bit in the opposite direction in this particular case. We were probably a little bit late to the party on price this year. We've done some great job, I think, of catching up. But of course when you see a declining market, it is harder to get price, but we haven't found anything in our history that would suggest that we have to give up price. So I think that the chances of that happening, Alina are low, but I think it's a good question.

Okay. And one other thing. Can you just talk about where the vitality index is now and kind of how it's tracking and what's really driving that?

Yes, sure. Well, it's running around -- I think our target for the end of the end year, we were hoping to get to around 33, but it's running around 32. There was a big -- this is just a sort of, in a sense a part of it is an exercise in arithmetic, there was a big drop off of the big Optical product that was $500 million in sales. So arithmetically, it was just a bit of a harder target this year, but it seems to be running very, very well. I got some data from Chris Holmes in the industrial business yesterday that suggested this thing continues to accelerate and we think ultimately, it's unquestionably the way to make sure our growth rate is sustained. Notwithstanding the fact you do get these transients that most people in our company do see, and they come and they go. And we see both sides of them. We get the penalty when their adjustment is down, and we get the benefit when their adjustment is up. But they're not long-lived. They're typically about 6 months, and we hope that patent will follow here in this particular case too.

And that's the corporate average. If you take Electro and Communication, it's way above that. And that's also one of the reasons why we continue to make sure we make the right investment in Research and Development as we move ahead for some of those businesses. One, Electro and Communication, where it's very important to have the latest technology as the market will turn at the time here, which we think is in a couple of quarters.

Our next question comes from the line of Shannon O'Callaghan with Nomura.

On the margins for next year, maybe just a little more color. I mean, Health Care, you're saying, high 20 sweet spots, so that kind of stays where it is. I thought that was kind of the thinking on consumer too as you try to build that more internationally. So are there any segments were you're expecting sort of greater than 100 bps to get the whole thing up more?

I would say, again, early planning, we haven't finalized, Shannon, so we'll do that in December certainly. But do we expect any big swings? I would say probably the area that we'll be focused on in terms of possible change in margin will be in D&G because we expect frankly, that the TV business, which is part of the Optical systems division, is likely to continue under pressure next year for us, which will put some pressure on the margin in that business. But -- so take that into account. We think that it's still reasonable to expect to move the business backup, in this case, more to a 22% type margin from where we expect to complete the year at 21%.

And you can expect, Shannon, in some places -- as you kind of scan down the array of businesses that we have and the geographies that we have, there are different leverage ratios in different businesses. Some are at 1 or a little under 1, some are at much higher. And the obvious correlation is those that have the lowest leverage are those that we're making most investments in where we expect the highest growth, and those that we have the greatest need to either restructure or find ways to cut cost and get productivity, they will have the highest leverage. And so let's say, it's a bit of a smorgasbord of different numbers right across the company. But net-net, certainly not preliminary work, it looks well within the chance of doing.

Okay. And then you mentioned sort of weakness spilling over into Factory Automation, which was kind of interesting. I mean, is that isolated to kind of the electronics end markets that you're seeing or maybe a little more color on that comment.

Well, I made the comment because what I wanted to do is not just dump consumer electronics, but to recognize that some of the businesses that we serve, serve not just consumer electronics, but electronics more generally in medical and even in Automotive in some cases. So I wanted to just hint to people that it's not -- this is not just in these locations alone, and you can well imagine that if weakness was to persist for a long time in consumer electronics, but then you have to expect that it would then ultimately begin to creep out in other places. We do see it in our results, Shannon, we do have, for example, in the Industrial and Transportation business, our industrial Adhesives and Tapes business which is in that segment serves the electronics market -- all electronics markets, and they certainly saw some softening as well, which was consistent and contemporaneous with that in the more traditional electronics businesses that we report separately. So the -- I suppose the thing that we all wonder about is, is this going to be contained only in this area. The beauty of electronics is the blasted thing comes back so fast. I remember, Shannon the forecast on TSMC utilization being at 35% in 2009, and some people tried to convince me that they would remain under 60% for 5 years. And I said, it's just not going to happen, guys. And so these things, just they do, they do recover very, very quickly. I mean, you could argue that there needs to be a catalyzing event in the end market, but I think it's too soon to -- I could be forecasting any broader malaise, and with a little bit more data, we'll know, but I think for now it's a bit too early for that kind of forecast.

But just to clarify, are you seeing that spill over into Health Care, on auto and other areas yet or you're just saying if it continues, we would expect to?

I'm suggesting if it continues, we'd expect to. It's not in Health Care right now. In fact actually the Health Care results, as you've seen, they had a tougher period of time last year and had begun to sort of recover this year, in fact, they're doing quite well. And Automotive has really followed the same pattern. You do have a little bit of sort of another fly in the ointment as you might say, which is this issue of Thailand. You've got these floods in Thailand, and Thailand is a great source of Automotive components for the world, in particular for Japan. And they have a very -- they are a strong 2-wheel market. So, as I sometimes say, just when you thought it was safe to go back in the water, not to use a pun in Thailand, we may yet see some other cascading impacts from our supply chain in Thailand that give Japan a little bit of a ding as well. So that's additive to this mix, and it's too soon to tell whether that will be or will not be a problem.

Our next question comes from the line of Jeffrey Sprague of Vertical Research.

Having mentioned Japan, I wonder, George, Can you -- are we totally kind of normalized there? And I'm wondering, have you seen or are you seeing any insurance recoveries in Japan yet?

Japan is actually probably doing a little bit -- notwithstanding what I said about Thailand, Japan is probably doing a little bit better than what we thought, and it's probably a little bit in advance of where we thought in its recovery. So I think that part of it is okay. Remind me the second piece of the question, Jeff, I forgot sorry.

Insurance recoveries.

Any insurance recoveries yet?

Oh, insurance. Yes. We've not actually got any money in over the transient, but we met with our insurance people yesterday and there were some -- without me being specific about the numbers, because David will strangle me if I am, there was a reason for optimism that's somewhere around half of our number -- of our impact might get covered.

Is that included in your guidance?

No, it is not.

Okay. And I'm just wondering, bigger picture on Display and Graphics now. I guess, the good news on all those pressure on TV is that, what's the percentage of the Optical segment has to be declining definition? How far are we away from some type of crossover here where handhelds and other products maybe, overtake TV in surface area or dollar value or however you want to look at it?

Very close is the answer to that question, Jeff. Now we're down at about 20% detachment rates in TVs. That thing historically in the old days, in the glory days of Optical, was up in 70s, it sort of went through a transition over a period of couple of years. Bumped down even as low as -- we were expecting to go as low as 12 or 13. I don't think it have actually quite made that number. But it's certainly going into the teens, and now we're bumping along in the 20s. I think in all candor, it's really -- it's like a tale of 2 cities, it really is. The mobile device, hand-held type device market, even the monitor devices, some lovely new innovations due to hit the market in monitors that you'll see that we benefit from. But in the -- that seems to be completely robust. It's a wonderful, wonderful business. It grows rapidly, highly profitable. TVs on the other hand is the flipside of that coin. It's a market which is characterized by way too much capacity, it has scrambles per share, full channels, incentives to retailers, incentives to consumers to flush it out. And of course then, that all backs up in very, very heavy pricing pressure on people -- so that TV piece of the business is not all that profitable, but net-net, Optical is still very profitable. So I think we're getting to the point, Jeff, as you asked really, where it's just ultimately, I think in 2 to 3 years, becomes a vanishingly small part of the problem and ultimately, if not disappear, it will certainly fade into the background of our company.

Great. And just finally, Inge, good to have you on the call. I'm wondering if you could give us a little more granularity on Europe, I think until this quarter, most companies would say weakness is in the periphery, but maybe not so much Germany and other places. But we have been hearing now more kind of weakness in the core. Can you just elaborate on what you're seeing in Europe and how you think the fourth quarter plays out?

Yes, I think -- as we all know, as many things going on in Europe. Everything is starting maybe with consumer confidence that is down, right? But if you look upon it geographically, there's a -- it's a couple of places that still are doing well. And Germany is doing relatively well, so is Nordic and also the Alpine regions. So that means that Germany, Switzerland and Austria, together with Nordic, are still doing well for us. And I'm saying, well, we have local currency growth there in the quarter from 8 to 12 percentage. So doing well, slowing a little bit. And why it's slowing, it's very much also due to the fact that there is a -- government spending is down, which means that for traffic safety and security, that will slow down our business and also a little bit into Health Care of course, right, even if that's a private sector. So that's slowing a little bit. And then we saw, generally speaking, I would say, over Europe in this quarter, specifically, as you saw our growth was down that the manufacturing sector is cutting back production and over time in the plants. And Automotive was a key driver for that. So when we looked at upon it, we would say that, Industrial and Transportation business is a big portion for us, our company in total as the manufacturing sector slowed down a little bit lead by Automotive specifically, we felt that of course. And then you take the government spending holding on, which done -- it impacted Display and Graphics, specifically in Traffic Safety Systems. I think that's what we saw. You know, as we know that still, Italy, Spain and in some cases, U.K., has a little bit of challenge of growth. We also saw, due to the Industrial and Transportation, we also saw a little bit down in respirators, which is going into the overall manufacturing sector. On the other hand, if you take Central East Europe and Middle East Africa, it's doing well for us. So the growth is still coming there. We are doing well, and in fact, Middle East Africa, as you know, we've been -- not we, but the world have had a war that's going on there. And our organization, they have done remarkably well. Now one thing that I would say relative to Europe is, everything is coming down to leadership. And I can tell you that our leadership in West Europe is remarkable and very strong. We have local managing directors in those countries except for 2, which is in U.K. and in Iberia. And those people have been through this before, and they are very, very experienced. And they can take, under this localization strategy that George laid out and we have executed here the last 5 years, this is now a string for us. We have very strong people on the ground that no other countries, and can act immediately. They don't need to wait 24, 48 hours in order to figure out what is going on and get some direction from us back here. Being on the country, they can take action immediately, they speak the language and have all the authority and we have empowered them to take action very fast as things are becoming tougher. So I will say that, the one thing I think that we as management here feel very good about is the strength of our leadership as managing directors back in West Europe and in time like this when we see news, the whole time and everyday in the papers, so what is going on or what is not going on, you sleep a little bit better when you know that you have a very seasonable management back there.

Our next question comes from the line of Terry Darling from Goldman Sachs.

David, I'm wondering if I could just clarify the commentary on the fourth quarter organic picture. I think I heard essentially D&G expected flattish year-over-year, Electro and Communication down significantly and the other businesses kind of close to 0. If we focus on an average that gets us to 0, which gets you to the high end of the 3% to 4% range, is that basically the picture?

Yes. Just to walk through it again, we expect in D&G and ECB for Q4, on a year-over-year basis, to be down negative growth, which will be somewhere between 0 and mid-single digits. And then the rest of the business as we expect, will continue to run close to the levels -- around the levels that we saw in Q3. Does that help?

In terms of the year-over-year growth rates?

In terms of -- yes. Yes.

In other words, Industrial and Transportation around 8%, Health Care around 5%, 6% [indiscernible that gets you to 0?

Yes, that type of the trend. So what I expect when we close the year, if I look at my total organic volume for ITB and SS&PS, it'll be at the low end of the original guidance range. So we had said 7% to 9% for ITB for the year. I expect to be towards the low end of that range. SS&PS, we had said 4% to 6% for the year. Again, I expect to be at the low end. In both cases, the key driver of that, which is a softening from what we expected when we were on the call in July is primarily around Europe and a little bit in ITB. They sell into the electronics business.

Terry, those are the annual numbers. We can work through the, what it means here off-line.

I guess just where I'm heading with it is, to try to understand in the context of the new guidance, are you assuming that you have further deceleration in 4Q or that the rate of decel in September just kind of continues into 4Q?

Yes, we're looking at 4Q right now as being in the range that we experienced in the third quarter. So relatively flat.

Okay. And to try to come at the impact from inventory, I don't know if it's possible to do this, but if you look at, just the delta in the organic revenue growth guidance for the full year, call it 3.5% versus 7%, about $800 million on a year-over-year basis, I'm just wondering is there any way to swag at what the impact from the inventory clearance in electronics and other areas might be in that context?

Yes, this -- it would be a slag. This is George, Terry. Recognizing it's really a good idea to make too many swies, but I would say that's -- it's a good -- that inventory question -- it's probably 1.5 of growth on the year will be my guess.

Okay. that's helpful. And then, just in terms of the confidence in improving margins next year, how are you thinking about R&D? I mean, you got sort of this 2-speed world where developed markets -- it's where the pressures are coming from ex-electronics, which is global. You're starting -- you're trying to still grow the emerging markets. How does R&D shakeout in your thinking preliminarily here at this point for '12?

I don't think there's any material change in our outlook on R&D, Terry. I mean, it comes from a couple of points. Number one, these are not like factory resources that you can kind of turn on and turn off. These are PhD scientist that in the end -- they're not something you can park away and bring them back in a quarter or a half years time. So you have that challenge. Above and beyond that, we've always taken the view, Terry, it certainly works so very, very well for us in 2009 that we can't eat sea prawn -- in this kind of time, it's ever more important to build and differentiate our products through new product development in R&D. And it's worked so well for us. So in the future, Terry, I don't see any material changes in that as an approach. We may have the margins, we often have -- David and I and now Inge have a little bit of a kitty that we keep to one side that we will invest in new business development. That can be $100 million, even $200 million in some years. We probably will be -- a little bit more circumspect with those sorts of things. But I think in the net core R&D, we don't expect to change our philosophy essentially at all.

Thanks, everybody. It's a busy day, with a lot of companies reporting. We have a few still in the queue, and I apologize. We are going to end the call, but we'll follow up directly with those that are in the Q&A queue. George?

Well, thank you very much, everybody. It's great to talk to you all again. And we look forward to talking to you sometime in December. Thanks a lot, guys. Goodbye.

Goodbye.

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