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Executives

Matt Ginter - VP of IR

George Buckley - Chairman, President and CEO

Patrick Campbell - SVP and CFO

Analysts

Scott Davis - Morgan Stanley

Jeff Sprague - Vertical Research Partners

Terry Darling - Goldman Sachs

Laurence Alexander - Jefferies & Company

Bob Cornell - Barclays Capital

Steven Winoker - Bernstein

Stephen Tusa - JPMorgan

3M Company (MMM) Q1 2010 Earnings Call April 27, 2010 8:00 AM ET

Operator

[ABRUPT START]

As a reminder, this conference is being recorded, Tuesday, April 27, 2010.

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

Matt Ginter

Welcome to our first quarter earnings call and business review. Before we address this quarter’s results, I want to mention two up coming events. First is our up coming Plant Tour and Consumer and Office Business Review, scheduled for the morning of June 29th, at our posted manufacturing facility in Cynthiana, Kentucky.

A formal invite will be sent out shortly. In the meantime please hold the date. Also as I mentioned on the January earnings call, we have set aside the morning of Tuesday, December 7th for our Annual Outlook Meeting in New York City. Complete details regarding timing and location will be available later this year.

Before I turn things over to George, 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 out future performance and financial results. Those statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions.

So, let's begin today's review. Turn to slide number three and I’ll turn it over to George.

George Buckley

Thank you very much, Matt and good morning everybody. By now, you’ve all seeing the numbers and we hope that investors are happy with our progress in first quarter. Last quarter, I told you that I’ve never been more confident in our growth prospects and the first quarter is exhibit Asia we call and just the reason why we feel that way.

It was spectacular quarter of many contribute especially gratifying as an affirmation of both our strategic direction and of implementation of our plan. A few highlights if I may please.

Sales grew by 25% in the quarter this was the largest single percentage quarter increase in any memory or record yet, with organic volume improvement over 19%. Adjusting for special items in this case Medicare Part D earning was $1.40 per share, an all time 3Mregard for the first quarter.

We maintain our best-in-class margins at 22.8%. up 700 basis points year-on-year. I can think of no better way to refuse some of the collection margin doubt in (inaudible). The strong performance was across the board, all of business posted double digit sales growth along with 20% plus operating income margins and some like display and graphics, electrco and communications and industrial and transportation were particularly outstanding.

Geographically, sales growth were strongest in emerging economies where sales expanded by 47% versus the first quarter 2009. We are trying to posting a huge volume gain at 63%, Korea 74% and Taiwan whopping 88% gain. (inaudible) in March we had 16 countries across the world by the sales growth was 50% or better, yes 16 countries. Korea and Taiwan were 75% in March and these are not small businesses.

United States was no slouch either in this growth rates. Sales were up over 11% in the quarter and up 18% in March. This was done even while we committed to accelerate R&D spent this year by apparent $100 million. Over the next two years, there’s no doubt in our mind that this additional spend is going to accelerate our growth rate substantially, is a proven formula for us and we intend to ride it.

Across the total line, this raises a number of key questions, for us, why do we see [segment] interest in growth in the quarter? Where is it coming from, and what is it mean for this year and the years beyond. Second, why do we feel confident in raising our guidance by $0.50 on both the low end and high ends of the range, which is a very healthy increase only three months into the year?

We’re seeing improving numbers in most company earnings report so far this quarter with high growth rates in Asia. So that far of it is not surprised to anyone, but this quarter’s growth rate exceeds any conventional market expansion explanation we have. Let me take you through our best thinking about, where the 25% sales increase came from. Understanding, that in a company like ours with so many moving parts in markets, decision is always a new elusive animal to apprehend.

There is what we know with reasonable certainty, acquisitions, net of divestitures added 0.3%, crossing in aggregate added 4.2% and currency translation added five percentage points. The remainder of course is a super organic growth number of over 19%. I’d like now to try to help you understand where the growth came from. So let’s spend a minute as to analyzing the 19% jump.

We now said with you (inaudible) geographic breakdown, where a leader of wholly IPI not a wholly GDP company, though we have elements at both in our mix. To a rough approximation, $6 billion of our annual sales worldwide GDP dependent, $11.5 billion our worldwide IPI dependent, $3.6 billion our Asia IPI, and $5 billion our US GDP.

While we use the Global Insight forecast numbers on slide 3, we get a blended customer market index of about 7.2%, pretty close to the 7.3% worldwide IPI number for the quarter. So that explains 7.2% in our market growth, leaving 12% still to be explained.

I see more cushy numbers inventory restocking. Some commentaries from our industrial peers suggest that this part of the growth dynamic is over. Well across, we’re not sure we have the (inaudible) get started. Moreover quite a few of our supply chains, consumer electronics in particular and automotive too for that matter have a little or no channel inventory to speak off, so they are not really a factor involved in driven by supply chain transient..

In the US, if you look at the census for your data on inventories, they haven’t moved up a lot. Last day they showed US inventories moving up by less than 1% year-over-year. Historically, (inaudible) sales transients was just 1% factor is, we see the sales result magnified in the channel by various factor. So we would expect some of our US sales to be impacted by this condition.

Given our roughly, one-third mix of US sales are practically would spread above 1% of the quarter's sales growth, but we are also conservative, are going to extend it globally saying the amounted to the same total worldwide. That would explain 3% of the growth with 9% still to be explained.

Another factor is new product. We’ve done our level best to drive these other metric growth, knowing full well, is the best source of value creation, and new product vitality index is running close to 30% on a five year basis, headed to 40% at the end of the planning period. Offsetting these, we will be using an estimate of 2% to 3% erosion and cannibalization annually, but I think manage the (inaudible) strategy may have used that erosion a bit. Of course it’s difficult to discern the difference between penetration from new products and market share gains. They aren’t exactly mutually exclusive concepts, but our best estimate point to a new product gain of 3% to 4% of this sales growth. That leaves four or five points of additional growth in the quarter to be explained, and that leads to the inescapable conclusion that we’re taking market share.

Now as an engineer, I was trained never to determine a small number from the difference into large numbers, but this is as good as we can get right now and candidly, I think we also gain significant share in the fourth quarter too. To support that view, look at what three indicators alone are telling us about sales in some key markets.

First, in automotive for example, worldwide auto builds were up 39% in Q1. In comparison, our unit growth for the quarter was up 67%, well in excess of the auto build proxy. Second, if we use Intel’s Q1 logic and chipset unit growth as a proxy for sales growth in the consumer electronics industry.

Volume was up year-over-year by 44% with average selling price about flat. Correspondingly, Gartner also reported PC shipments in Q1 were up 27%. In contrast, our electronic related businesses grew at about 85% for the quarter and was very broad based, not just LCD TVs. Again, while this is not an accurate scientific comparison, it is a leading indicator of significant penetration.

Third, in consumer, same store sales in the US naturally varied widely, but the best performing companies grew same store sales by 2% to 4%, the orders were negative. We grew volumes in the quarter by nearly 11%, very impressive when compared with same store performance of big box outlets in the United States. Global GDP was up only 3%.

This was great execution of the plan by 3M people, but also because of the vibrancy of our new technologies and products. I’ll give you a few examples quickly of how the plan is working. Especially is it relates to growing our core new products and manage the pyramid more effectively.

Example number one (inaudible) acquisition [Nylonj] enabled to homecare division to realize increase in sales with 20% year-over-year, by driving up the pyramid with branded products and this is one on of our mature core businesses, scoring products. Second our entry to renewal energy demonstrates our result not to back off investing in the future.

We form this division in January 2009 during the darkest days of the recession. Essentially about bringing together technology in products from all across 3M to address nearly every facet of renewable energy components. Solar mirrors for example shown terrific growth and sales in renewable energy are up 72% in the first quarter. We build a new coating line in Singapore for this business. We grew opened last September and it’s already sold out. We’re working on the next one as we speak.

Third, the Electro and Communication business is another example of 3M staying the course on investments in the future. Promising this business include a hugely successful optically clear adhesive for use in touch screen applications. Novec fluids in carrier tapes, ECB sales were up 39% in Q1.

Fourth, an example of reinvigorating our core, industrial adhesives in tape division is paying much more broadly across the entire product spectrum and its growth in Q1 of 31% was impressive, and the long line of new inventions continues with new tape product that includes holy grail of adhesives, it will stick to another surface, believe it or not. So in summary, it was a great quarter, well ahead of any market trends and probably with the good share penetration gain element to it.

Now, I’ll turn the call over to Pat, and he will give you some details on the quarter.

Pat Campbell

Thanks George and good morning everyone. Please turn to slide number 4, on our GAAP reported basis, first quarter earnings were $1.29 per share, a healthy 74% increase over the first quarter of 2009, included in that result was a one-time non-cash income tax charge of $84 million or $0.11 of share resulting from a Medicare Part D changes embedded in the recently enacted Patient Protection and Affordable Care Act here in the U.S.

Our prior earnings expectations from the January earnings call were based upon the tax line effect as of the date and therefore do not contemplate this change or charge. So excluding this item, earnings were $1.40 per share, which is an all-time record for any first quarter in the company’s history, up 89% versus the first quarter of 2009 GAAP earnings per share.

Importantly, we achieved this result less than a record sales. As our first quarter sales were still below 2008 levels. So there’s no doubt that we’re running the company today with a much more competitive cost position. On the whole, our first quarter performance was ahead of our own expectations. So the year is off to a very strong start.

Let’s examine a few of the details, please turn to slide number 5. Since the worst of last year's recession, we have now put together a string of outstanding quarters, and the first quarter was the best thus far. First quarter sales increased nearly 25% and this growth came from virtually every part of the world.

Asia Pacific grew 54% and the combined Latin America, Canada regions expanded sales by 26%. European sales grew 15.9% and growth in the US was 11.6%. We experienced double-digit worldwide sales increases in every business segments led by Display and Graphics of 42%, Electro and Communications of 39%, and Industrial and Transportation at 29%.

Gross profit grew 34% year-on-year, gross margins rose 3.5 points to 49%. In a number of positive factors worth work here including the 19% growth in organic sales volume, substantially improved factory utilization levels along with cost savings related to prior year’s restructuring actions. Currently, we are sustaining those gains.

Finally, our [metal] Six Sigma teams continue to drive significant yield improvement and cost reductions efforts throughout our factories. As the economy improves, we shall see a nice continuous stream of productivity and efficiency gains. SG&A cost increased 11% which included a 30% increase in advertising and promotion investments to drive future volumes. As a percent of sales, SG&A declined by 260 basis points.

We invested $342 million in R&D in the first quarter, the year-on-year increase of 6%. Given how all the business is performing, we recently improved an additional $40 million of investments for the remainder of 2010, spread across a number of businesses to drive new growth programs. These investments will largely impact the SG&A and R&D lines of the income statement.

Operating income rose 80% to $1.4 billion and operating margins were an outstanding 22.8%. The first quarter tax rate was 31.9% on a GAAP basis which of course includes the charge related to Medicare Part D.

Excluding this charge the tax rate was 26%, which were 4 points better then last year's rate. Due to a lower international tax rate along with the resolution of our 2008, US federal tax audits. In light of this, we now expect our full year tax rate to be at 28% or lower, excluding the impact of the Medicare Part D. It is encouraging to us that strategy is really beginning to play out in the numbers. Growth is accelerating, cost remains under very good control and margins and returns remain among the best in class.

Sequential P&L highlights were on slide number 6. It is clear that our business is improving quarter-by quarter. Sales increased 4% as both our Industrial and Transportation and Electro and Communications business pose it great sequential improvements across most of the respective operating units.

Gross profit rose 6% sequentially, driven largely by stronger factory throughput along with higher sales levels. First quarter raw material cost was flat to slightly higher than the forth quarter, as we are seeing some up-tick and inflation, they will begin to affect us in Q2. Both SG&A and R&D cost low as 5% sequentially partially due to higher stock option expense.

You may recall that because we have stocks options in February of each year, our first quarter expense is higher than the fourth quarter. Operating income rose 8% sequentially despite of five points rate from options, and incremental margins were raised strong at 46%.

Now, let’s turn to the balance sheet in cash flow, please turn to slide number 7. All we know the one of our key objectives entering the recessions was the focus on cash flow generation and are carefully managing our balance sheet. For example to keep a close eye on receivables balances and I’m monitoring the financial conditions of our customers in order to optimally manage credit terms. Also we put actually emphasis on driving higher inventory returns and made it to top priority in our 2009 planning. Now that the business is growing again you can see that these offers are really paying off.

First quarter free cash flow was $925 million, a record for any first quarter in the company's history, and more than two times that of the prior year. Free cash flow conversion was nearly 100%.

Now, working capital turns were 5.3 in March month end, a 20% improvement versus March 2009 levels. Inventories rose by 5% year-on-year, a modest jump in a quarter when sales rose 25%. As a result inventory returns were 4.4 at 10% improvement over the first quarter of 2009.

Accounts receivable increased 15% year-on-years again well below sales growth levels. March sales typically the highest in the quarter, so there is not any visual to see receivables wisely even the quarter only the subsequently fall in early in the following quarters payments are remitted. Regardless accounts receivables turns were healthy 7.1 in March, up one after (inaudible) March of last year.

All-in-all, our working capitals are in good shape and we’re in well position as the economy improves. Capital expenditures for the quarter were $157 million, down $87 million year-on-year. We expect CapEx to accelerate in the remainder of 2010 and our full-year estimate remains in that range of $1 billion to $1.1 billion.

Dividends paid to common shareholders were $374 million for the first quarter including a per-share increase of 3% in February. This was the 52nd consecutive year dividend increases for 3M.

Now, let's review the performance of our business units. Please turn to slide number 8. Industrial and Transportation is our largest segment representing about one third of 3M sales and they had fabulous performance in the quarter.

First quarter sales in the segment grew 29% to $2.1 billion. The local currency terms sales were 23.7% which is almost entirely driven by organic volume. This growth was across the board in the quarter as most every business in the segment posted doubled digit local currency sales growth.

Sequential sales increase 6.6% in the first quarter, so the business continues to improve day-by-day. In addition to the great performance in automotive renewables and tapes the George mentioned were also positive double digit local currency sales growth [end of races]. Aerospace, purification systems and energy and advance material. All in all industrial and transportation performance this quarter was quite strong and very broad based.

And they are still plenty of upside going forward as unit volume just tell 10 points below the peak levels that we saw in 2008. Operating income for the quarter for $254 million, an increase of a 160% and margin is double to nearly 22%. The business list has taken out significant structural cost in the past couple of years therefore the operating leverage is quiet significant.

In the last three year under (inaudible) leadership, industrial and transportation has significantly stepped up his level of customer engagement and new product flow. Examples include our new (inaudible) tube a revolutionary self sharpening and bracing that provide significant productivity advantage to our customers. We are on track to begin best production of this product in the second half of this year.

We also recently introduced Scotchgard integrating (inaudible) film to protects against vandalism and mass transit in retail spaces. These are only two examples of many. We also receive some important customer accolades in the first quarter. Our automotive OEM team received Hardest 2009 Development Award recognizing technically significant contributions to the manufacturing processes, and also recognize of Japanese subsidiary, Sumitomo 3M, for developing an interior film for their upcoming new hybrid car.

[Honda is outstanding customer who you can't be recognize by empower efforts]. Our final business development though, our renewable energy business signed a cooperative R&D agreement with the US Department of Energy’s National Renewable Energy Laboratory to accelerate a number of clean power projects in order to help and meet the nation's carbon free energy needs.

Please turn the slide number 9, Electro and Communications for the first time in many quarters was one of our fastest growing businesses. During the worst of the recession, this team has been set faster in our sales efforts, working bench-to-bench with our customers to drive future growth opportunities. We are now finding the many of our competitors cut much deeper that we did, and now that businesses picking up there are plenty of demand coming our way.

In particular, this provided a boost in many of our optical clear adhesives, novec fluids, carrier tapes and wafer processing possessing materials for semiconductor manufacturing. First quarter sales in the Electro and Communications were $665 million up 38.6% in US dollars and up 34.3% in local currency. Foreign exchange impacts added 5.3 points of first quarter growth. Growth was once again led by our businesses that supply their consumer electronic and semiconductor industries.

They clearly drove most of the growth in Q1. But it’s also very encouraging to see double-digit local currency growth in our electrical market businesses were supplies, connectors and other solutions to power utility, MRO and appliance markets. On the flip side, our telecom infrastructure business related businesses have been (inaudible) grown in the market they remain very sluggish. Electro and Communication positive the side 20.6% operating margin in the first quarter, which is over four times up of last year’s first quarter. Much stronger sales in factory utilization were obviously a factor but I don’t want to take anything away from this team's ongoing commitment to productivity, yield improvement and waste reduction and the like.

They really did fine job navigating through the recession and are now reaping the rewards of those efforts, on the new business front, we continue to fight much more aggressively from market share in this business. For example we are driving increased to spec in of 3M components and touch enabled devices.

The semiconductor carrier tape was successfully expanded our product offering to participate more broadly and capture additional growth in consumer electronics, including the LED space. In the electrical markets with gaining substantial share in the North American OEM insulating tape markets by aggressively capitalizing on the access of reformer competitor.

The list of similar examples continues to grow, electro communications business is off to a strong start in 2010, look for continued improvement as the year progresses. Please turn to slide 10, where I will review our Display and Graphics business.

Display and graphics also deliver great strong first quarter, again consumer electronics was a key thing but the performance in the D&G continues to broaden out to other businesses as well.

First quarter sales were $869 million up 42% year-on-year, sales rose 38.4% in local currency which was entirely organic. Profits more than tripled to $212 million and operating margins were 24.3%.

Factory utilization was much improved versus last year’s challenging first quarter, and the business continues to do a tremendous job in reducing cost. First quarter growth was led by optical film business where sales doubled year-on-year, this was a function of both strong end market growth and consumer electronics, particularly LCD TVs along with a number of important new 3M product solutions for the industry.

The LCD TV market is rapidly transitioning to LED led from traditional CCFL bulb-lit technology and our films are playing vital role in this transition. Our films are also an important enabler in the ongoing transition to more energy efficient TVs. Of course, part of life cycles in this space are quite short and nobody knows this better than our team, so the leadership is relentlessly focused on next-generation solutions for the industry, and we continue to aggressively driving lean Six Sigma in our optical factory, so that we capture all available future sales and profit opportunities.

Another sizeable business within Display and Graphics is our traffic safety systems business, which is the leading global supplier of high performance reflected materials for the roadways and construction work zones. Traffic safety system had a fabulous first quarter with double digit sales growth, and solid profitability. Similar to recent quarter, growth continues to be very good in developing areas of the world, where highway infrastructure development continues to accelerate and stimulus spending is making a real positive difference.

Growth in the US on the other hand has been much more modest, as it appears at the legislative focus at the federal and state level is on areas other than highways safety. In recent Investor Meetings, we have talked quite a bit about broadening our product offering to play bigger across the entire product pyramid. Traffic safety system is one business at 3M that does this very, very well. For the past two years, we’ve offered films assessed by our customer needs across the entire spectrum, good, better and best if you will.

In addition, the team has (Inaudible) better in this global leadership position films with adjacent offerings and reflective pavement markings, roadway maintenance systems and service and vehicle registration systems.

Traffic safety systems remain a very steady performer within displaying graphics, which nicely compliments the more volatile growth trends that are inherent in consumer electronics. Commercial graphics also had a very solid quarter with double digit growth and continue sequential sales improvements as the advertising segments that reserve recover from recession.

This business has recently introduced new promotional films to compete more broadly across the product pyramid. Finally, within our newly formed mobile projection systems business we received some nice accolades for a new 3M 150 Pocket Projector which was named Nelson Award finalist in technology category. Winners are to be announced later this month.

Please turn to slide 11. Sales in the consumer office space rose 15% in the first quarter to $912 million. Local currency sales rose 11%, the majority of which was organic growth, we also had 2.6% growth from acquisitions in the quarter. This growth happened throughout consumer and office in our business in geographic regions posted positive local currency growth.

As George mentioned our Home Care business posted tremendous growth in the quarter, we recently acquired two smaller yet very strategic companies in Latin America to expand our presents in this market. We also drove double digit local currency growth in the consumer Health Care business which we bolstered in the past couple of years with two very important Bolton acquisitions (inaudible).

We now have a formidable consumer health care line up across the retail landscape. The do it yourself business also posted very nice sales growth driven by our command adhesives and Scotch-Blue Painter's tapes. To drive volumes in these and other critical brands, we increase first quarter advertising and merchandizing investments by over 40% and even with this high investment levels first quarter profits in consumer offers rose 33% to $219 million and margins were healthy 24%. All businesses drove double-digit profit gains in the quarter.

Finally, I will be remiss if I did not mention that 2010 March 30th anniversary of Post-it Note. Three decades after this introduction, this category defining brand continues to grow with the slow new offerings and adjacent solutions.

Please turn to slide 12. In safety, security and protection services, sales grew 20.4% in the first quarter. Local currency growth was 14.7% and currency effects added 5.7% to first quarter sales. As in the past few quarters, the biggest growth driver here was a personal protection business or more specifically respiratory products.

As a global leader in protective respirators, we’ve seen significant growth related to H1N1 virus for several quarters running. We estimate the H1N1 related sales were approximately $45 million in the quarter which is about one half the impact we saw in the fourth quarter. So clearly the impact has begun to wane.

On the flip side, the industrial manufacturing sector is picking up resulting in additional respiratory growth. We expect this transition to continue which should help us successfully manage to wane down the H1N1 related activity.

Elsewhere in the safety, security and protection services, we saw outstanding growth in the roofing granules business, which we attribute primarily to inventory build at this point. Until we see signs of residential construction and roofing placement activities fundamental improving, we remain cautious about growth in any one quarter.

We also process our growth in our building and commercial services business where we continue to take market share in the area of Floor Pads and Cleaners, including the Scotchgard brand for finishing systems. You can see here on the chart that we had a nice win in the first quarter, involving John Hopkins Medical Center. First quarter operating profit was $181 million in Safety, Security and Protection services, up 46% year-over-year and margins were 22.4%.

Please turn to slide 13 for a final business review, Health Care. Through the worst of last year’s recession, we’re often reminded of how important it was to have a thriving Health Care business in our portfolio. End markets in this business continue to grow nicely and generally speaking those markets are highly stable.

First quarter sales in Health Care were $1.1 billion, up 12% in dollars and 7.6% in local currency. Foreign exchange impacts added 4.6% to first quarter sales. Sales increase in most every business within Health Care, led by double digits currency sales growth in both infection prevention and in skin and wound care. We’re seeing good demand in a number of important areas including skin integrity and advanced wound care. We also continue to drive growth with our new Tegaderm CHG Dressing for I.V. site, which was recently launched in both Western Europe and Brazil.

Elsewhere in Health Care, we drove solid single digit local currency growth throughout most of the portfolio. Drug delivery systems grew nicely as demand picked up for the traditional inhaler fills. Oral care continue to accelerate growth with orthodontic products showing particular strength during the quarter, and we drove mid single digit local currency growth in health information system where we recently introduced our new 3M Mobile Dictation Software for iPhone, Blackberry and Windows Mobile platforms.

Looking at sales by geography, local currency grew in all major areas, led by Latin America at 19% and Asia Pacific at 16%. Operating profits was 13% to $347 million and margins were just over 31%. Health Care continues to gain recognition both from customers and with industry experts. For example, the business has usually recently named the Number Two Most Admired Company in the Medical and Precision Equipment space by Fortune Magazine.

Our oral care business once again was named most innovative dental company by the Anaheim Group. 3M oral care has now won these for five years in running. In a food safety, a Clean - Trace ATP system was chosen to monitor sanitation of food preparation at the 2010 World Expo in Shanghai. Health Care continues to exemplify innovation at 3M.

That concludes my review of our business segment. So, now I will turn it back to George.

George Buckley

Thank you very much, Pat. Well, let’s take a look now at the remainder of the year. I like being on this side of the gradient a lot better than I did the other, but in reality the forecasting which get no easier, I think you have very long large growth rates when you have very large contractions. I will do to demystify for what’s happening.

There’s certainly lot of forward momentum in our sales volume, so the (Inaudible) is how this will pay out in the coming quarters. We’ll show so good sales growth in the fourth quarter. We can think one of observation being a data point, two being a trend, and three all more to me is a pattern. So I think, we’re closely seeing whether this growth is in fact have pattern or just a temporary abrasion of wary economy dealing with recovery.

Perhaps, we had inventory, others didn’t, or we could find them sit where, others couldn’t. (inaudible) my target it will slip back as growth normalizes and credit availability improves and ultimate could argue once the shares is us to lose to as to win. I’ve heard comments in news media that anyone now doubting a strong US recovery is silly.

Result has said that maybe uncomfortable uncertainties formal ridiculous. It is nothing magical about where the bank comes from, it comes only when and from where people or companies spend money, we’ve observe increased order slowing non-cycle companies, because it's no optimism now on the likelihood of sustainability. The housing stocks in the United States increased in March by about 20% year-over-year to an annualized rate to 626,000 which is also 1.6% up on February.

Non transportation rate of durable goods orders rose by about 3% and we sold that some of the appliance make it results. US also has been the best performers and improved by 21% and much more helpful numbers that (inaudible). The total sales in these factors are only a bit more than $100 billion annually target big stimulus in US.

In contrast to these gains, US commercial construction would probably still get worse before it get better. Now, do I expect capital spending in telecoms or in to utilities to increase in the immediate future. In summary, I don't think we should look to the US for big recovery in 2010. More likely is going to be a slow, patchy and gradual recovery, punctuated by period of occasional back sliding. Unemployment rates fall in the logic could be the genesis of any sustained US recovery and productivity gains are set couple lot of any increased demand.

So we retained to right to be cautious in this period of uncertainty or driving for much more growth as we can get mean time as conditions unfold. But just because we cautious in conservative doesn't mean we won't and can’t drive for good growth. We've already shown that. Unfortunately by for the biggest piece of our recoveries coming from overseas market, substantially in early in emerging markets, it's also coming from large developed Asian economies such as Korea, Taiwan even Japan. Japan’s sales grew in the first quarter by 35% by 38% in March so hope for overseas growth is still much better than the United States.

Demand at this rate is likely to be maintained at least into the middle of the second quarter, (inaudible) transient took about two quarters to settle in the downward economic slide, economy is probably by directional. So that element of growth might subside in early Q3.

H1N1 demand is also according to pass and with phase of 1.5% growth that in the second half, that I also believe improved industrial demand will offset some of that anticipated decline and new low cost products will help too.

High material and waste cost in the second half also factor. For you information USPPI increased by 6% year-over-year in the first quarter. Then you have the simple arithmetic issue of how the year-over-year comes in the second half.

This is obvious for a conservative stands in the second half at least for now. The main point however is that no matter what shape the recovery takes, 3M in a much stronger position to face economic growth than we ever were even once a year ago.

Our forecast that when the term would come was very accurate and that avoided the need to over react. We never pull back on investing on the future and that has to be helping. So let me address our outlook for the year.

With a strong first quarter behind us, we’re raising our full year 2010 expectations. We now believe that organic sales growth will come in between 10% and 12% versus the prior expectation of 5% to 7%, that is almost doubling our forecast sales growth rate. We also expect that earnings per share will fall somewhere be in the demand of $5.40 to $5.60 on an adjusted basis versus a prior expectation to $4.90 to $5.10. We anticipated operating margins will return to the 22% plus level for the year, which is a level we just last saw in 2007. So the business has really responded well coming out of the recessions.

The 2010 tax rate, excluding Medicare Part D charge is expected to be less than or equal to 28%. And finally weighted average shares outstanding should fall some where between $723 million and $737 million for 2010 in total.

And that concludes our formal comments for today, and we will be happy now to address your questions. Thank you very much everybody for listening.

Question-and-Answer-Session

Operator

(Operator Instructions). Our first question comes from the line of Scott Davis of Morgan Stanley.

Scott Davis - Morgan Stanley

Hi, good morning, guys. Pretty big core gross number you put together there.

Matt Ginter

We really thought its pretty good, Scott.

Scott Davis - Morgan Stanley

About three years of growth in one quarter. Anyways, couple of things, guys you didn’t spend a whole lot of time in the presentation talking about use of this free cash flow and you are sitting very nicely on a fairly large cash balance your obviously had some dry powder there. What's out there? You've got a little bit of share count slippage in your forecast. Is there anything holding you back from buying back shares, or is that just reflect on how strong the M&A environment could potentially be for you this year?

Pat Campbell

Scott, obviously there is a very good question and I guess the way were thinking of it is corresponding of our growth opportunities is the highest party for the company. You look at our results in returns that are obviously what we think as the best pay back for the shareholders, and we think the long term growth prospectus for the company. So we are continue to obviously push the organic side of it, we did indicate that we are going to increase some of our investment programs unlike, but importantly we are active in the M&A market.

We have announced anything, we are looking at fair amount of deals are in the pipeline, neither George or I feel compelled, though to be pushed okay to utilize the cash that we have in appropriately. So we will remain our cautious sales we always have will be but we are looking at a number of deals across our businesses, probably more focused internationally than recent track record would lead you to believe because of part of it is we do have more cash outside of the US and much more our cash generation capability outside the United States, and we think we are just huge growth potentially outside the United States as well. We made a number of small strategic deals in home care that we have talked about in the like and we were prospecting for those across the logos as we speak. But I would guess more like the second half of the year before you would see much relative to anything of size.

George Buckley

Scott, we follow the same pattern that we always have slightly can we close to call; it will be very easily manageable. I don't think Pat or I see any hugely disruptive or blockbuster acquisitions. And when you look behind these numbers one thing that perhaps we didn’t emphasis strongly we might it done is, we’ve got a lot of places in these new advanced technology that we’ve release, Scott. That really capacity is just being mopped up immediately. So, we do have some pretty good internal choices although they obviously small relative spend time they are relative to some of things he is speaking about. So, overall I think, situation gives great choices and we’ll develop as the year unfolds.

Scott Davis - Morgan Stanley

Sure. Guys, as a follow on, your Asia-Pacific growth numbers 47%, big numbers, and if I was to make one particular last several years, I would say that I thought your Asia-Pacific growth was a little, China in particular, a little bit disappointing versus the potential. Obviously, we’ve inflected up there. What do you kind of attribute that to? Is there a wider rollout of SKUs, is it capacity? Is it sales? I mean what do you kind of attribute that inflection point in emerging markets?

George Buckley

Well, we have been building plans Scott, last few years. So, there is no question having locally available capacity is part of issue I think, that we followed a China for China strategy. We don’t use China is an export source. The other thing is that starting really about a year ago we began to hire lot of extra people for a lot of extra money.

We have growth expansion plan in the industrial and consumer office, in medical and so the money has been put to work Scott and now we begin to see some of the opportunity coming through, So we are actually in the process of reorganization where we can are getting closer contact with the market, and I think clearly the number demonstrate, but I think the future holds this wonderful prospects, so that part of the world and they do same in India and in Russia too Scott. We are building in building new lab, they are sitting our last quarter conference call. That’s turned out to be for us to allow, to not being absolute money bank guarantee on growth. So I think it's reason to expect that this will continue not withstanding any other issues the China itself may have in the economy.

Pat Campbell

Yes Scott there was a piece I was going to pick up on was that I think the piece that would really have start to see a large traction on is our local lab capability in places like China, and have really started to develop a lot of new product idea, so you met skews so forth. They were getting a lot of new products of our developing market lab organizations these days to get price at more appropriate for these markets.

Operator

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

Jeff Sprague - Vertical Research Partners

Thank you. Good morning, everyone

Matt Ginter

Good morning.

Jeff Sprague - Vertical Research Partners

As you said, there are a lot of different things and it’s maybe hard to totally deconstruct the magnitude of your out performance. But I wonder if you could elaborate on the idea that you or Pat alluded to, I don't recall now that competitors cut perhaps too far and were left flat footed by this. And clearly, they will try to rebound, but I guess just thinking about the competitive dynamics. How big of an impact do you think that was and what can you do to extend that lead now that you’ve established it in a few key areas?

George Buckley

Well, I don’t think there this sort of comment Jeff, with this (inaudible) my engineering training and trying determine a small number subtract in difference in two large numbers both of which we’ve got either a result or variability in them. So it’s really hard to get down on those numbers, I mean it’s especially muddy Jeff when you see the huge number of markets we serve and the huge number of product. So everything ends up being a little bit of this and a little bit of that. But we are seeing some competitors getting weaker. I really what to try to do my level best to impress on you the hugely significant change in the way we’ve gone to market here and particularly in the optical business. And we always, we tended to serve the OEM markets, we are little bit disconnected there from the set manufacturer in particular, we have altered that completed.

We’ve gone right to the end markets. We’ve reestablished trust and I think in the end most of these guys Jeff, they believe in us, they believe this is the place where the innovation is coming. They see the product you are seeing coming out in the market. This is the stuff that being invented by 3M, even the facilitating LED technology being facilitated by 3M. So one thing is very, very different here is the relationship between us and our customers, and I'm hoping what that does is secure and at least maybe to some cases if you’re drifting away, that we get early warnings. But I’m hard pressed unless, Pat’s got a better idea to absolutely quantify how much of that sort of early share, shall we say we’re grabbing. It is very difficult for me to generally answer. We’ll ponder it for you Jeff, unless Matt or Pat has got a better of the tough idea.

Pat Campbell

Jeff, I don’t think we can give you a precise answer numerically, but can probably give you some of your more qualitative. We saw going into the recession that a number of large OEMs wanted to secure a much more reliable supply chain and we saw that really play out through last year as far as gaining new designs. We just didn’t see the volume and so the recovery came.

Then I think the flip side is also happening now is that as the economy improves, I think there’s some competitors who were having more difficult time responding. So I think we’re getting some business back on that side, but I say it’s just pretty much across many of our industrial and electronics business, okay. They’ve been very successful and gaining business there.

Jeff Sprague - Vertical Research Partners

A separate question, just pick one end market to talk about, maybe if there's others you want to elaborate on, but the push into labels, what you are doing with A1? How significant is that market opportunity, and how should we think about the rollout there over the next six to 12 months?

George Buckley

I think, Jeff that market for labels is of the order, $0.5 billion a year and A1s, $80 million or so I think it's a very nice marketplace clearly and actually would expect 3M is the innovative in that area. So I think it's a nice adjacency very much close to (inaudible) material science. So I think it obviously depends on the end market reaction and those successful at getting competitive convergence in the marketplace, and there’s some tough competition, but I think that we will be successful in that market not only in the coming year, but I think ultimately innovation and great services going to be the difference. So I think is going to be a good market structure.

Operator

And your next question is from the line of Terry Darling of Goldman Sachs.

Terry Darling - Goldman Sachs

I wondering if I could understand some of the pieces of guidance a little bit better maybe come at it from a couple of different angles. The first one would just be very simplistically, if you take your first quarter earnings by four, it's at the high end of guidance. But we’re building momentum, March versus January, February. Can you just take us through your thinking on cadence quarterly earnings, cadence throughout the year? I guess your comments would lead me to think you think that the second quarter is up from the first, but maybe the second half is down, at least as implied by the guidance there, maybe start with that?

Pat Campbell

Terry you’re trying to attract me back into quarterly guidance ago, which you know we are not going to do, but let me try to give you little bit of flavor. You can take our first quarter you're annualizing okay, you kind to get to the high-end of the ranges one way of approaching. and of course, yes, some unusual thing, Q1 we got the stock option expands a hiss that okay and we actually at a lower tax rate okay in Q1 those have tendency kind of offset. But do expect that our normal trend would be that our Q2, Q3 are higher okay than Q1, Q4, it will kind of a normal, kind of course we advance the way that we will see it.

Now of course the comps are going to get from a reporting standpoint a little bit unusual here because of course the second quarter was weaker last year than as with the year progressed at the back end of 2009, ended up with some stronger periods and of course, we had a very strong performance in the back half of the year well to the H1N1 demand both on the top line, which were probably impact on our comp assure by about a point now from the back half of the year from a revenue perspective and obviously from a earning standpoint, well. But do expect that generally speaking Q2, Q3 okay should run probably a little bit ahead of the Q1 and then Q4 naturally would have a tendency to fall off a little bit off of Q3, Q4. So I don't see ending this highly unusual this year from kind of a traditional seasonality perspective.

Terry Darling - Goldman Sachs

From another angle trying to understand what’s implied in the incremental margins and guidance? If I take the high end of the range on our EPS and kind of the low end of the range on organic and I kind of look at what the incremental were implied for the rest of the year versus 2Q versus 4Q of last year. Kind of looks like, 17%, 20% incremental margin. You mentioned a couple other factors in there, I just want to make sure I’m clear on what you’ve changed on some of these items. I think I heard you say it, you’re taking R&D up $100 million versus previous?

Pat Campbell

Yes, I guess Terry two things, one is: let’s start with the year as a total. For the year, when you look at our change of the top line, bottom line effectively our incremental margins in that 35% to 40% range which is kind of our long-term rate that we have been running to in kind of guide to of course we did a little bit better in the first quarter. What we said is that some of our new growth investments which will start to kick in back towards the back half for the year.

We had already talked about maybe $115 million going into the year. We said that we will probably invest another $40 million or so in George’s comments he kind of wrapped R&D together okay and talked about $100 million increase in R&D across this new growth programs would be part of it. So that’s part of the impact that will hits on kind of an incremental basis on going forward basis, and also remember that starting with the second quarter we will re-launch somewhere compensation related programs like merit plans and so forth that we had kind of frozen for the last year.

So if you look at the top line and bottom line is more reflective of point through our operating margin okay, level is for the back half of the year.

Terry Darling - Goldman Sachs

Has anything changed on that the raw material price, raw material spread assumptions?

Pat Campbell

I would say not change hugely, you should expect that mature cost will start kicking up here in Q2 on us, but that has been in our plan. Of course we have some very aggressive cost reduction program on the material side as well try to offset as much of this possible. So I would not put it as a significant change from our prior expectations?

Terry Darling - Goldman Sachs

I wasn't exactly clear on the H1N1 delta. Maybe just tell us what you are now looking for that business to be down in total for the year maybe.

Pat Campbell

Okay, I’ll describe give you order of magnitude more than likely our 2010 level would be in the $100 million of range revenue. Last year we did about $250. So, of course you got a significant change will be first half of this year and Arroyo was last half of last is on the impact. So, you get a benefit of first and second quarter of this year and then really you get kind of the deterioration in the back half of next year turns.

Matt Ginter

Terry, we had each of the third and fourth quarter about roughly $90 million to $95 million of each one and one related sales last year. So, that’s the 1.5 point drag the George refer to even the second half of this year.

Pat Campbell

I think, again offset by an unknown amount of the industrial recommend we should not factor into numbers, which we help, and we do have a very nice new product program where we are getting ready to launch and my compensate some of that volumes. So, we need to be pessimistic on that but I think we are trying to tell you the best of we know on the profile those sales of the year.

Terry Darling - Goldman Sachs

I'll ask one more and get out of the way here. D&G margins were one of the big upsides here in the first quarter. If we go back historically, you’ve gotten those as high as 30% plus. It doesn’t sound like you see inventory as a problem there, George.

George Buckley

No.

Terry Darling - Goldman Sachs

What keeps us from continuing to track higher with those margins?

Pat Campbell

Right, well first of all you are not going to track higher business, we are not going to go back to the margins that we had three to five years ago just a dynamics that industry will not allow that to happen. And I think when you look at the margins of the D&G had 24% margins in that collective businesses is a very good result, and it realistically as well as optical business maintain stronger, which we expected to do here in the near future, will be able to run it those kind of rates.

Operator

Your next question comes from the line of Laurence Alexander with Jefferies & Company

Laurence Alexander - Jefferies & Company

Two quick questions on your growth rate. First, as you look at doubling your growth rate assumption for this year, how much of that change in perspective was driven by your electronics exposure? And secondly, as you think longer term, how much of the market share gains on the retail side do you think is permanent versus transitory?

Pat Campbell

Well, I guess on the retail side still has been more permanent I don't see those beings a transitory change in all large, and I guess I haven't looked that the change in guidance by end market per se, I guess if you just look that plus taking our guidance by five points you could argue that maybe 30% to 40% of that probably is kind to be electronics related, that would be a little bit higher than what our total businesses okay, in electronics, but when you look that I think were the growth rate is so forth is cross some more businesses that probably be a kind of more than order magnitude number Lawrence.

Operator

And your next question comes from the line of Bob Cornell with Barclays Capital.

Bob Cornell - Barclays Capital

Thanks. You had to put up a good quarter for me, I appreciate it. I think we get did message. The $1.40 was great and the guidance may have an element of caution in it. I guess a lot of questions have been asked. I would say in terms of the pyramid pricing, you mentioned traffic as one business that has benefited from the impairment pricing strategy, and maybe you can just comment just broadly across the portfolio how much you saw there?

Pat Campbell

Well, I don’t have a complete number for the pyramid as a whole, George said we would try to dissect the pieces, George, do you want to comment?

George Buckley

One number we calculated for last year, we though it about $200 million of additional sales that is coming from this manage the pyramid strategy. Of course, we’ve only just started and you can imagine, Bob this is a kind of step wise strategy for us, we have many more areas that we can attack, and I think the figure has been so nice is that we haven’t seen deteriorating by the managed system to get the cost on both products, right. And the pricing expectations have been, I think well managed. So I don’t know if we can expect that to be double this year up to 400, but I think it gives you some kind of sighting shot on what contribution it makes to end this year.

Bob Cornell - Barclays Capital

Yes, I agree. Looks like you guys are doing a lot right. Looking forward to the following.

Operator

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

Steven Winoker - Bernstein

First question is around the exceptional growth in Asia-Pac. So it was down 26% last year and core growth up 46% first quarter this year, how much of that was optical system? I know optical system doubled in total but if you sort of looked at it within Asia-Pac I am trying to get it sense for how much Asia- Pacific was really optical related?

Pat Campbell

We’ll have to probably pull that out.

Steven Winoker - Bernstein

But let me move on to the next question and within the health care margin they had 31:1 and I know you’ve talked about re investment in the second half overall, and lot of it the cost coming back historically. Can you comment is your vision for margins in that business completely consistent with where you guys were when you talked about that in the last four five months?.

Pat Campbell

I think it is Steve what we’ve said is that overall long -term period of time that business maybe in the high yield a high 20s, it’s a great business and the more volume that you have to, it’s a very profitable business, so it's able to maintain the 30% type margin without really starting it, what we’re hoping to do is over time that what we can do is find additional growth investments in that business which may bring us its margins down, but I don’t anticipate that is going to happen over night. There will be more of a gradual change as compared to a kind of a one quarter movement actually. That’s a fantastic business and if you just do the math it's pretty hard to bring that margin down if you got any kind of growth going on.

George Buckley

Behind the scenes there’s a lot of work going on, moving up business obviously protecting the call that we have that moving up business to at even more advanced footing. So, we’re looking any investments in advance. We’ll care a lot of look on using very advanced mathematics to diagnostics. Taking extracted signals from some of the advances we have been using that so we’re doing some internal development on that looking at least long or possibly two acquisitions in that area.

So I think, what you’re going to see is it kind of a bit of a technological mix of more electronics, more software, and more mathematics that will augment the great businesses we already have. Actually, even in some senses kind of repositioning that business a little bit, taking on various areas of Health Care and particularly various areas of the hospital in operating theatres and so and so forth, and putting together a fully integrated set of a product suite products to meet all other needs that consumable needs in particular they’re in those areas.

So I think the strategy at the beginning unfold the steps are being taken Steve, it’s a bit of the watch this space, but I’ve given you kind of a little bit of a preview of some of the ways, places that we’re thinking in this business. That’s right I think, you’re going to see margins, I don’t see them dropping below the high 20s, but for time, we will spend more money in that and hopefully this will remain for many, many years, just like great businesses of 3M, it’s a wonderful business.

Matt Ginter

On your first question, historically, a few years ago virtually all the growth in Asia was optical for a while but this quarter it was quite balanced. Optical was probably a little under third of the growth in Asia-Pacific and the remainder was really spread across the rest of the portfolio.

Steven Winoker - Bernstein

On pricing, given the big snap back, you talked about it a little bit, I mean what kind of pricing pressures or desperation you’re seeing as volume comes back from the competitive set and you guys are actually facing across the businesses?

Pat Campbell

Steve, I wouldn’t characterize it at all as any kind of an abnormal pressure. I think part of course what you’re seeing is, I think demand has snap back so rapidly here in Q1 in a number of spaces. The biggest concern we’ve had the suppliers and I think others have had is supply capability as much as anything right now, and I think once we get the supply system where it needs to be then obviously, you can get into price discussion, but right now, I think the biggest concern a lot of us have is, can we get product.

Steven Winoker - Bernstein

You answer to that as you look forward and plan to ?

Pat Campbell

We’re planning kind of a flat pricing environment for the year, this year Steven, we haven’t changed that view.

Steven Winoker - Bernstein

Lastly on the R&D front, I know you increased spending of $100 million. Sales, it was still far ahead of that thought that you faced a lower percentage of sales on that. As you look forward and sort of temper the growth rates a little bit, your overall R&D spending, would you spend more if you had the right projects at this point? How do you think about funding that? You talked about the $40 million of new investment. How should we think about that?

George Buckley

In the beginning of the year, we have a process where we look not only at the R&D spend, but because it’s a development spend and we obviously try to make a balanced judgment on how much extra we’re going to invest to make sure that we don’t damage the overall number. So a little bit of sort of a baby bear balancing act.

So we have the ideas and what we choose to do in this first quarter, because things are as strong as we accelerated investment. That pattern I think is likely to continue during the year if things stay very, very strong, we will see where else we can do the reinvestment loan, knowing full well that this is an accelerated to our growth. It would cost something in the near term but would be very, very powerful for us in the long term. So I don’t think you should think that we have an idea in fact is the complete opposite, it is one of the real changes in the company as its really gain traction in the this reinvigoration of R&D, these wonderful new ideas are all over the place, and is just a question about privatizing, funding, while at the same time balancing what we do for the market.

Operator

Our last question comes from the line of Stephen Tusa of JPMorgan. Please proceed with your question.

Stephen Tusa - JPMorgan

You talked about some of the temporary costs coming back in into the second quarter. Is that significant, or maybe if you just flesh it out a bit?

Pat Campbell

Steve, I don’t as being significant is obviously manageable within the size of our business and obviously taking into consideration in our guidance for the year, I think on the comp side is about $0.04 to $0.05 on they gone quarterly basis is kind of what we are probably putting back into the system but what we can manage.

Stephen Tusa - JPMorgan

Okay and then as far as the earnings that you gave at the beginning of the year which is always very helpful, aside from the obvious things you have already talked about like price cost and some of the organic dynamics, is there anything else in there that is changing in that bridge?

Pat Campbell

I will say the big change Steve as really been in the volume side. If you go back to our December meeting or any other conversation we had is the biggest change in that whole waterfall really has been on the volume side the equation.

Stephen Tusa - JPMorgan

Just one last question on the level of growth you saw in the first quarter. Maybe this just because it's picked up in the back half of the year, but seasonally, the first quarter relative to the fourth quarter has at least as things pick up kind of if you look back from '03 to '07, the average increase has been about 4%, and the sequential increase this quarter was about 4%, obviously the comp is tremendously easy and I'm not discounting the growth rates. I mean the growth rates were off the charts year-over-year, no doubt about it, but are we missing something there? Is there another way we should look at this to judge how strong it is, just to judge kind the progression of the economy here?

Pat Campbell

Yes, you got an appropriate comment if you look at kind year-over-year and so forth from a comps standpoint, but Steven really coming off the fourth quarter, you have to remember that fourth quarter was actually a good quarter for us. We had very decent quarter specially vis-à-vis any kind of the economic indicators in life. So we have seen good sequential change in our business and actually what makes us feel good about actually increase in your guidance for the whole year is really the rate of change that we have had in our business. I don’t see there is anything unusual there at all.

Stephen Tusa - JPMorgan

Okay and then one last question, the progression for the rest of the year. Obviously another good second quarter coming on the organic side, and you gave a slide last conference call talking about the second half growth rate at 2% to 4%? Are you bumping up the back half to the second half as well? I'm just curious as to the progression of the organic growth through the rest of the year?

And is the fourth quarter positive?

Pat Campbell

Well, it should be positive and just wanted to remind you, back half of the year as Matt had pointed out each one and when we do have kind of headwind about a point and a half in the back half of the year, but we will be positive if you take our guidance and you kind of extrapolate it implies kind of 7% to 10% growth rate through the back half of the year. My guess it kind of anticipate just the concept private be a little bit better in the second quarter that is in the back half of the year but that’s how we are thinking of the business.

Stephen Tusa - JPMorgan

Is that 2 to 4 goes up, obviously?

Pat Campbell

Yes, it does.

George Buckley

Okay, thank you very much everybody. We’ll close our call right now. Thank you very much for listening. We very much appreciate the time you spent with us, and we look forward in talking to you again the next quarter. Thanks everybody.

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Source: 3M Company Q1 2010 Earnings Call Transcript
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