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Executives

Matt Ginter - Head of IR

George W. Buckley - Chairman, President and CEO

Patrick D. Campbell - Sr. VP and CFO

Analysts

Deane Dray - Goldman Sachs

Scott Davis - Morgan Stanley

David Begleiter - Deutsche Bank

Jeffrey Sprague - Citigroup

Shannon O’Callaghan - Lehman Brothers

Stephen Tusa - JPMorgan Chase & Co.

John Robert - Buckingham Research Group

3M Company (MMM) Q2 FY08 Earnings Call July 24, 2008 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the 3M Second Quarter 2008 Earnings Conference Call. During the presentation, all participants will be placed in a listen-only mode. After which, you'll be invited to participate in a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 24th, 2008. We would now like to turn the call over to 3M.

Matt Ginter - Head of Investor Relations

Thanks. Good morning, everyone. This is Matt Ginter, Head of Investor Relations for 3M. I'd like to extend a sincere welcome to all investors and analysts for our second quarter 2008 business review. You will find this morning's presentation on our Investor Relations' website at 3m.com, and these slides will remain on the site along with an audio replay of today's call for an extended period of time.

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

Also allow me to put in a brief plug for our upcoming investor meeting in St. Paul on September 9th. You should have received an e-mail last week with a link to our registration site. If you've received the invite, please take a moment to reply as to whether or not you plan to attend. And if for some reason you did not receive an invitation, either drop us a note or give us a phone call and we'll give one out to you ASAP.

Registration will close on August 29th. As for usual, today is a busy day and there are many companies are reporting earnings, we will do our best to keep the call to one hour. Again, you could help during the Q&A by limiting yourself to one question and one follow-up, so that all questions can be fully answered.

George Buckley, our CEO and Pat Campbell, our CFO will both make some formal comments today, and then we will get to your questions.

So, now please go to slide number three, and I would like to turn the program over to George.

George W. Buckley - Chairman, President and Chief Executive Officer

Thanks, Matt, and thank you everyone for joining us this morning. Today I will make some brief opening comments, and Pat will then take you through the detail of the quarter. And then I will return to address some of the key issues including the state of our optical film business and our outlook going forward. After that, we're happy to address your questions and comments.

So, to get started, our second quarter is perhaps best characterized as a repeat of the first quarter, a good quarter especially when you look at the core of the company. Whether it was any negative color, it was mostly provided by the secular change taking place in optical films. But, on balance, it was a quarter, which we fought our way to a good overall results.

Over the past two and a half years, we spent most of our time investing in and strengthening the core businesses of 3M, driving international growth and fixing our supply chains. 3M has owned and operated these core businesses for many years, in fact one of them, abrasives, we won for over a 100 years. It's primarily this recent strategy of reinvestment in our core and in international that has made the current results possible.

Despite all the headwinds at Optical, Commodities, and the U.S. economy through with us, the fact is that we still met our numbers and delivered the beacon. I'm also pleased to report that at the operational level 3M is performing superbly with our largest three businesses posting double-digit increases of sales in the last quarter.

So, after that brief introduction, let me turn it over to Pat for an in-depth discussion of our strong second quarter. Patrick?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Thanks, George, and good morning, everyone. Please turn to slide number four. Indeed this was a very good quarter for 3M and the positives far outweighed our challenges. We posted record sales for the sixth consecutive quarter, and five of our six businesses achieved strong growth in sales and profits, including double-digit profit growth in three of our largest businesses. We are pleased that margins were 20% or better across the board. We converted nearly 100% of net income to free cash flow in the quarter, which enabled us to return nearly $1 billion to our shareholders via combination of dividends and share repurchases. On the other side, the challenges we face will now surprise you. The U.S. economy remained difficult, particularly in those areas that touch the consumer. George will update you on Optical Systems later. And finally, commodity input prices continue to rise which pressured our raw materials somewhat, but we have a good pricing story here, which I will address here in a few minutes.

Please turn to slide number five. All information that I will present today will exclude special items. So, allow me to summarize the special items quickly to get them out of the way. Last year's second quarter results included a net gain of $0.02 per share from special items. The second quarter of 2008 reported earnings per share of $1.33, included a net charge of $0.06 per share related to a loss on the divestiture of HighJump Software along with charges for asset activities at an industrial and transportation manufacturing facility in the UK. Excluding these special items, Q2 2008 earnings per share were $1.39 as compared to $1.23 per share in last year's second quarter. Please refer to the attachment in today's press release for a more in-depth discussion on special items.

Second quarter sales grew almost 10% to $6.7 billion, which represents the sixth consecutive quarter of record sales. In our three largest global businesses, namely Industrial and Transportation, Health Care, and Safety, Security and Protection Services, revenues expanded at a double-digit clip.

On a local currency basis, sales were up 4.6% versus last year. Looking at the business geographically, sales growth was once again strongest in our international operations. Sales grew at a double-digit pace in Latin America, Europe and in Canada, and a 1% in Asia-Pacific. Importantly, if we adjust Asia-Pacific results for Optical Systems, sales growth was nearly 17% during the quarter. Operating income was up 8.5% to $1.5 billion as four of our six business segments delivered double-digit operating income percent increases.

Operating margins topped 22% for the quarter with all six of our business segments achieving 20% plus operating margins. For several years in succession, we've continued to maintain best-of-breed margins regardless of the business environment. The strength of our broad business portfolio overcame a tough U.S. economic environment, all time higher raw material prices for many key materials, and a secular transition in our Optical Film business.

I applaud the efforts of 3M as everywhere for pulling off what many deemed a possible that is maintaining superior operating margins while simultaneously investing in growth programs for the future. Earnings per share in the second quarter was $1.39, up 13% year-on-year.

Please turn to slide six for an in-depth review of the second quarter performance versus the same quarter last year. We have again isolated the impact of Optical Films in order to help you better understand our results. The strength of our global portfolio was again evident in the second quarter as sales increased almost 10% or 14% ex-Optical. This 14% growth was a combination of organic growth, acquisitions, and of course positive currency impacts. This marks the sixth consecutive quarter of record sales. Gross margins were down slightly from last year's comparable quarter. It was no surprise to us that raw materials rose year-on-year in the range of 3% to 4%. Excluding the Optical business, we are able to offset this inflation with selling price increases along with relentless process improvements and cost reductions overall. So, once again we're effectively managing through a challenging commodity price environment.

Operating profit grew by 2.5% or 18% ex-Optical, and our premium margins continued at 22.1%. And finally, our tax rate improved by almost two points to just under 31%, consistent with our tax reduction strategy.

Earnings per share rose 13% to $1.39 per share. Excluding Optical Films, earnings per share would have improved by nearly 24% year-on-year. Let's now focus... let's now shift our focus to bring it down to our second quarter sales growth performance. Please turn to slide number seven.

Worldwide sales growth in U.S. dollars increased 9.7%, led by our International operations with sales growth of 11.9%. U.S. sales growth was up 6% in the quarter. Second quarter local currency growth was 4.6% with organic growth up 40 basis points, price up 10 basis points and acquisitions, primarily Aearo Technologies adding 4.1%. Excluding the impact of the Optical business, local currency sales increased 8.1% as organic volumes increased 2.5%; selling prices increased 1.1% and acquired volume was up 4.5%.

International sales on a local currency basis increased 3.4% in the second quarter. Organic volumes increased 1.8% with five or six businesses posting positive organic volume growth. Selling prices declined 1.1%, including a 12% price decline in Optical Films. Acquisitions added 2.7% to international local currency growth in the quarter. Ex-Optical, International local currency sales growth was 9.1%, including 5.5% from organic growth, 3.1% from acquisitions, and 0.5% from selling prices.

On a regional basis, International local currency sales growth was led by Latin America at 21%, followed by Canada at 7%, and Europe with local currency sales growth of 6%. Local currency sales declined 4% in Asia-Pacific due to a 37% local currency decline in Optical. Excluding Optical, Asia-Pacific sales in the local currencies increased 10% over the same quarter last year.

Economic conditions in the U.S. continued to remain challenging, especially in the retail, housing and automotive OEM markets. Second quarter local currency sales increased 6.6%, driven by 6.5% impact from acquisitions. Selling prices increased 2% in the quarter with all businesses delivering price increases as we tried to offset the continued high price of commodities, while organic volumes were down 1.9%. Four of our six business segments delivered sales growth in the U.S. during the quarter.

Please turn to slide eight, where we will briefly comment on our year-to-date progress. At the end of the second quarter, year-to-date sales were up 9.3% with operating income up 6% and earnings per share were up 10.8%. Excluding Optical, year-to-date sales were up 12.4% while profits increased 15.2%. And finally, free cash flow was up 4.7% year-to-date versus the first half of last year.

Please turn to side nine for a review of the balance sheet and cash flow metrics for the second quarter. Free cash flow for the quarter was $909 million versus $866 million last year. Free cash flow conversion for the quarter was nearly 100%. Working capital turn were 4.9 turns, down slightly year-on-year and in line sequentially. Foreign currency translation increased accounts receivable inventories by $243 million and $167 million year-on-year while reducing them sequentially by 36 and 13 respectively.

Second quarter capital expenditures were $334 million, down $14 million versus the same quarter last year and up sequentially by $36 million. Through six months, we have spent $632 million on capital expenditures, and expect full-year CapEx to be in the range of $1.3 billion to $1.4 billion. Dividends to our shareholders were $351 million during the quarter, consistent with past quarters.

Share repurchases totaled $572 million in the second quarter, which is up slightly from initial quarters. Weighted average shares outstanding were 712 million, down nearly 3% year-on-year and 1% sequentially. And lastly, our debt-to-cap ratio was 32% at the end of the quarter.

Now let's delve into our performance for each of our segments for the second quarter. Please turn to slide ten for a summary of our results for our largest segment, Industrial and Transportation, a business where innovative solutions help manufacturers improve their businesses. With broad-based revenue growth across the portfolio, Industrial and Transportation delivered an outstanding quarter with sales of $2.1 billion, up 15.5% and operating income up 18%. Sales growth in the business was led by our Industrial adhesives and tape business followed by our automotive aftermarket, abrasives and closure systems for personal hygiene products.

Local currency sales increased 8.7%, including 4.2% from acquisitions. Year-to-date sales were up 16.3% with operating income also up 16.3% as operating margins held steady at 21.5%. All geographic regions saw growth in the quarter, including the United States. Strong market penetration continued in emerging economies, especially the BRICP countries where the business grow a strong double-digit organic local currency growth. Elsewhere around the globe, we saw a double-digit growth in Europe, Asia-Pacific and Latin America.

Some of the products driving growth in the second quarter were abrasives used in automotive shops, laminating adhesives providing attachment solutions in industrial applications, diaper closure systems, and packaging, masking, specialty tapes. Continued investment in new technology has brought some very innovative new products such as new glass bubble filler that can reduce the weight of automobiles and Clean Sanding Disc that can significantly reduce dust throughout various finishing processes in industrial market and automotive refinishing applications. Industrial and Transportation business continues to bring 3M technologies and solutions to high-growth market spaces such as oil and gas, renewable energy and the aerospace market.

Now, please turn to slide 11 for a look at the second quarter highlights for our Health Care business, where we provide the Health Care community with innovative solutions based on 3M technology platforms to improve patient lives and the productivity of health care providers. Health Care continued its exceptional performance for 2008 with broad-based sales growth of 13.1%. Profits rose nearly 12% to $310 million. Local currency growth was 7.7%, nearly all organic.

Year-to-date, sales increased 12.5% with profits up 15.5% and margins increasing 80 basis points from 2007 levels to 28.8%. Three divisions drove strong double-digit growth in the quarter, namely Orthodontics, Dental, and Medical. With Orthodontics and Dental or our oral care business showing outstanding strength in leading the way. The U.S. market had mid single-digit growth while international sales growth was outstanding as all regions drove both double-digit growth for sales and profits. Some of the products that drove sales included advanced room care and surgical tapes, dental restorative materials and equipment for Crown and Bridge procedures and Self-Ligating Brackets for Orthodontics.

In our Medical business, we closed the Solumed acquisition further solidifying our position as a provider of leading edge medical products designed to prevent infections. Also, we're awarded top honors by the International Association of Food Production for a contribution of food safety technology.

3M's Dental business where we saw double-digit sales growth and profits holds in July, a deal for IMTEC, a manufacturer of dental implants and scanning equipment, primarily known for the many dental implant, which importantly patients can be treated by the regular dentists versus seeing a specialist. We also marketed the first sale of our Chairside Oral Scanner, a digital impression system that enables the motion capture of accurate and precise dental impressions.

In Orthodontics, we continue to deliver strong double-digit results, and we announced the deal to acquire the German sister company of U.S. based lingual pair [ph], expanding our offering for Digital Orthodontics products in Europe and Asia and helping to move the surging demand towards invisible Orthodontics solutions.

Please turn to slide 12 for a recap of our second quarter performance by Safety, Security, and Protection services, where our products increased the safety, security and productivity of workers facilities and systems around the world. Led by acquisitions primarily Aearo, along with organic growth in personal protection, window films, tiny solutions for commercial buildings and closure protection, Safety, Security and Protection services delivered sales of $1 billion for the first time ever, up 30.2% from last year.

Growth in local currency was 25.6%, including 19.8% from acquisitions. Acquired growth was primarily from Aearo Tec... Aearo Technologies, an Indianapolis-based global manufacturer of personal protection and energy absorbing products that aids hearing protection and fall protection lines to 3M's existing full-line respiratory products.

Operating income for the quarter was 30% while margins remained steady at 21.2% as compared with last year. Year-to-date, sales have increased 22% with profits up 21% and margins holding steady at or above 22%. Included in this operating income results are approximately $20 million of one-time Aearo acquisition-related cost, negatively impacting Q2 and year-to-date margins by about 2% for the quarter and 1% year-to-date.

Driven by the Aearo acquisition, sales were strong across the globe, led by double-digit increases in Europe, United States, and Latin America. In Personal Protection, we continue to see strong demand for our maintenance [inaudible] as well as reflected materials. And with the Aearo acquisition, we now offer a more complete personal protection solution that spans the industrial to military and construction markets. Our Speedglas Auto-Darkening filters and helmet product development team has been awarded Business Week's Gold IDEA Award for design excellence. In building the commercial services, we saw a strong demand for our floor maintenance products due to an increase in commercial construction in many parts of the world. Also we have continued to see steady growth in our corrosion protection products where we provide pipe-coating solutions to extend the life of both the underground and aboveground pipelines. In our Track and Trace business, we refined our strategic direction for the tracking of high-value assets, asset utilization, and safety and security applications in connection with this strategy strategically refinements to sold off the software business.

Now, please turn to slide 13 for details about our Consumer and Office business, home to some of our best known brands and enduring franchises, our Consumer and Office business improved from Q1 as sales increased 7.8% to $899 million in the second quarter. Local currency sales were up 3.5%, including 0.7% from acquisitions. Profits were up 9.1% with operating income margins of 20%. Year-to-date sales were up 5.2% and operating profits are up 1% which we feel as an outstanding result in the current business climate.

We saw a positive growth in all divisions with do-it-yourself and home care leading the way. Overall sales growth was tempered by weakness in the office mass retail channel in the United States. Geographically, 3M's international subsidiaries continued to drive growth again this quarter with double-digit sales growth in all regions, led by Europe and Asia-Pacific. Through expanded distribution, grand presence and merchandising programs, our Consumer and Office business drove outstanding growth over Filtrete... air filtration products for residential HVAC systems.

Working with key accounts such as Wal-Mart, Target, Home Depot and Lowe's, the Filtrete team delivered sales growth 75% in the second quarter versus last year. In our home care division, we recently launched the Scotch-Brite Ultra Nailsaver, as well as Fur Fighter Hair Remover has taken off with customers and which is reasonably been into us by Martha Stewart as well as gaining the good housekeeping legacy and seal of approval.

In addition, Consumer Reports just listed our Ultrathon insect repellent as an "everyday best buy" for 2008. We also launched our Nexcare cold-sore treatment product, leveraging our experience in manufacturing products focused on skin wellness to provide customers with lasting permanent relief from cold-sores. Other products driving growth in the second quarter were Scotch-Brite scouring products along with the Scotch Blue Masking Tapes and Command mounting and fastening products.

Please turn to slide 14 where I will provide an overview of results for the electro and communications business where we are also a leading supplier to the electrical, electronics, and telecommunications industries. Sales for the quarter increased nearly 8% versus the same quarter last year. Profits rose 11.4%, driven by outstanding cost discipline producing margins of 20.1%. Sales in local currency increased 2.2%, mostly from organic growth. Year-to-date, sales have increased 8.5% with profits up 12.5% and margins growing by 70 basis points to 20.1%.

Overall, electro and communications saw a double-digit growth in three of its businesses, electrical markets, electronic materials markets, and communication markets. International sales growth was the strongest led by double-digit growth in Asia-Pacific and Europe. Some of the products driving growth in the second quarter were outside plan and central office equipment used in the telecommunications industry. Insulating and Protecting products used in the electrical applications and electrical and power grid solutions used in the Energy and Electrical power industry. We continued to see our volumes for inkjet printer circuits decline which adversely affected sales by 1% and operating income by nearly 3%.

Today, our Aluminum Conductor Composite Reinforced or ACCR product, which allows energy suppliers to transmit more than two times of capacity without the risk in delays of major construction projects has had 25 installations with the most recent installs being announced in Shanghai, British Columbia, Brazil and Silicon Valley.

Please turn to slide 15, for a review of our second quarter results for Display and Graphics segment where we make the films that brightens the displays on electronic products such as flat panel, computer monitors, cell phones, PDAs and LCD televisions along with reflective sheeting for Transportation, Safety, Commercial Graphics Systems and Projection... Projectors and Projection systems. During the second quarter, we saw a positive double-digit growth in Commercial Graphics and single-digit growth in our Traffic Safety Systems, where we're recognized by the American Road & Transportation Builders Association with the first place award for environmental protection and mitigation. And if you watch closely during the upcoming Beijing Olympics, you will see our commercial graphics specialty films that work all around the sports venues.

Overall, second quarter sales for Display and Graphics were down nearly 16% with profits down 36%, driven by the sales and profit declines of 36% and 54% respectively in optical film business. Operating margins held constant at 21.7%. Excluding the optical film business and divestitures, Display and Graphics sales increased 5.3% and profits were flat. Display and Graphics saw the effects of the slowdown in the U.S. driven markets for Traffic Safety Solutions and Commercial Graphics. Highway construction and commercial graphics for the trucking industry have both slowed us results of sequential U.S. macroeconomic softness during the course of the second quarter. Despite the headwinds in the U.S., geographically, we saw a good performance in these businesses, led by Europe, Latin America and Asia-Pacific.

3M's Mobile Projection technology and also Compact LED-based projection engine for personal devices is now in production. We're continuing to see interest in this new technology across a range of personal electronics options, including cell phones, laptops, and PDAs. This concludes my formal comments, so I know I will turn the program back over to George to give you color on the optical film business, as well as our thoughts for the rest of the year. George?

George W. Buckley - Chairman, President and Chief Executive Officer

Thank you very much, Pat. I'd like first to give you another update on the transition of our Optical Film business. There are still many investors who don't know the background to the challenges of this business, so let me give you a quick phrasing. First, of the four Optical Film segments that we serve, three of them plus the polarized films are relatively stable and strong for us. The issue is of course in the supply of films to LCD TVs.

Fundamentally, the rapid rise of video as a club brand was the catalyst for this secular change. Beginning about two years ago, they rose from eighth place to first place in the U.S. market in less than nine months. They were able to do what they did by reducing brightness and all-time reviewing standards, because they are driving out of the costs to hit... keep price points and getting a great distribution channel. As new and lower price points were hit, the consequence explosion of the volume in the market at the bottom of the pyramid surprised us all. As the market commoditized, it rattled the large branded set manufacturers. They responded by following video e-content example and work to compete better.

The net result was the buying lower specifications, TV manufacturers were able to design out a lot of the high performance films, and 3M did not have the product at the bottom of the market for sale. We had needed that lower cost film products free or even four years ago. So, for 3M, the impact was that we suffered loss of volume from de-contenting, as well as huge pricing pressure leading ultimately to the results in financial transitions that we're experiencing today.

You'll recall that on our April call, we said that we expected the balance of 2008 to follow the same pattern for Optical that we saw in the first quarter, and also that it would be the toughest year of transition for that business. So, the pattern that played out in the second quarter was pretty much as we expected. Optical margins for the quarter actually came in a little better than our expectations though sales were a little bit low where we thought.

To give you an idea or the scale of the change, year-on-year sales of optical films for LCD TV applications have just declined by over two-thirds, while profits have dropped by 80%. It's up to dealing with the tough transition here; I think we can see the bottom even if we haven't quite reached it yet. I don't expect this sub segment to completely disappear since there are always a small percentage of consumers who want high performance from TVs and some films will be retained for that purpose.

So, what are we doing to manage through this transition period? First, the new management team has been in place in Asia for a few months now, and I'm impressed by their quick understanding of current realities, realities of both market dynamics, and the value proposition that we bring to our customers. A quick uptick is held by the knowledge of consumer electronics that was in that background. To strengthen our competitive position, we are taking additional actions to get our cost structure in line with these new market realities.

Today, we announced the elimination of 300 jobs in Optical Systems, all across the business mostly in the U.S., there are some overseas too, at least for G&A, manufacturing, R&D, and other areas. This represents a 20% staff reduction in that business. We're also improving manufacturing efficiency by consolidating several film converting sites in the Asia region. Collectively these two actions will save around $30 million annually.

Additionally, our former film converting plant in Poland has been taken out of the Optical Films division as it's been transformed into a multi-use, multi-division facility for other 3M businesses. We are also have intense manufacturing cost reduction activities underway everywhere and they're beginning to make an impact. As we said, margins in Optical Systems improved by a point sequentially as some of the cost reductions began to take hold. At the same time, we're actively addressing the market situation by simplifying our product portfolio and making it more relevant to our customers.

Our Optical products will continue to add value to our customers through technology, even in TVs. This is especially so as energy reduction is now becoming more important to set, monitor, notebook manufacturers and to consumers as well. Our technologies also contribute to the trend to work in a TV. I've said this before that 3M Optical Films allows a reduction of 50% to 70% in energy over typical configurations and consumers have that reduction today. You can imagine that we're working this issue very hard and it provides one of the upside opportunities in LCD TVs as discontinued unit growth.

So, to summarize on Optical, the bottom appears to be inside, if not quite here yet. And we have a new team in place close to our customers and we are aggressively taking cost out and we're working hard to maintain margins and protect the bottom line. We're expecting this transition to be complete in 2008 with the possibility of some bleed over into early '09, but if so, it's impact here should be small. Of course we're also working hard to maintain margin and protect the bottom line all across the company as we continue to drive our growth agenda and also even as we fight our way through these not too favorable U.S. economic conditions.

The fact described is tough out there, particularly in retail, housing, and automotive OEM markets. No surprise is there for anybody. And we will continue to see blips in some of our short cycle businesses where the impact of volume is realized quickly and fortunately with an impact stabilizes quickly also. I'll state as well that our approach to growth investments is a very practical one, it's not highly logical.

Like all public companies, we must always keep one eye on the long-term and one eye on the short-term. We're most certainly determined to drive growth for the long-term, but we will do so prudently and with the attention to maintaining optimal flexibility in the timing of those investments and as always, you'll see constant attention to operational discipline as it accompanies and enhances our drive to our growth.

So, let me quickly update you on our guidance for 2008. Please turn to slide 16. The reasons that Pat and I have outlined today, we remain committed to deliver the 10% plus earnings per share growth for 2008. With year-to-date operating income margins of 22.7%, we continue to expect full-year operating margins to be in a range of 22.5% to 23.5%. Our tax expectations for the year are also in the band, 31.5% to 32%.

And finally, our 2008 full-year capital expenditures range between $1.3 billion and $1.4 billion and it remains unchanged from the previous guidance. So, that concludes our formal comments here, and so now we're happy to take any questions that you might have. Thank you very much, everybody.

Question and Answer

Operator

[Operator Instructions]. Our first question comes from Deane Dray from Goldman Sachs. Sir?

Deane Dray - Goldman Sachs

Good morning.

George W. Buckley - Chairman, President and Chief Executive Officer

Good morning, Dray.

Deane Dray - Goldman Sachs

Yes. I'm not sure if you gave us data point, but it would be helpful on the Optical Film businesses, how... what was the impact on price and volume in the quarter?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Well, price was down 12%, and I think total volume... total volume... was 36%, I think volume was 24%.

Deane Dray - Goldman Sachs

Okay. And that down 12% is still within the band of what has been the recent transfer, or was it like that worse, and is that correct?

George W. Buckley - Chairman, President and Chief Executive Officer

That's correct.

Deane Dray - Goldman Sachs

And then just... if we would re-calibrate, where these LCD TVs now fit in terms of the Optical Film sales that used to be in that 30% range? Where does it stand today? What is it on a run rate basis that will contribute?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Well, as George mentioned, Deane, it is a kind of a declining piece of the business. It's probably more in the... probably 20%... about 25% of the business on a current basis.

Deane Dray - Goldman Sachs

Okay. And then just a quick last question, if I could. How much should pension contribute in the quarter and what we're seeing in the unallocated portion there?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes, Deane, that number will stay the same throughout the year, and it's about $100 million for the year, so it's $25 million to $30 million for the quarter.

Deane Dray - Goldman Sachs

Terrific. Thank you.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Thanks, Dean.

Operator

Our next question comes from Scott Davis from Morgan Stanley. Sir, please continue with your question.

Scott Davis - Morgan Stanley

Hi, Guys.

George W. Buckley - Chairman, President and Chief Executive Officer

Good morning, Scott.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Good morning, Scott.

Scott Davis - Morgan Stanley

I was positively surprised on the margins given some of the raw material prices that we've seen just most notably on the Dow Chemical. I guess my question really is, it looks like your mostly FIFO accounting is the impact of the big nature in price increases is not quite fund through to your margins yet or are the big price increases out there, that... are going to offset this? Just a little bit of color on that please.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes, Scott, you're correct. We're primarily a FIFO-based company, but don't be worried about a huge increase coming through the system here. What we saw in the second quarter was a 3% to 4%, we don't see a significant change on the... for the Q3, so don't anticipate a drop off here.

Scott Davis - Morgan Stanley

Does that mean the price increases in the upper or does it mean that... in the materials a little bit less of cost of goods sold than what I have in my models?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes, raw materials will probably go up sequentially a little bit, but we also have further price increases going in effect in the third quarter as well.

Scott Davis - Morgan Stanley

Okay, fair enough. The last question really relates to inventory at the customer level, Consumer and Office came in stronger than we expected, and doesn't totally match up, I guess with results we've seen from other companies like Avery Dennison, for example. Do you have a sense for inventories at your customer levels? Are the customers buying ahead of some of these price increases or anything that could be teamed as unusual?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Scott, if I was to kind of characterize the consumer business, just, kind of overall. We started to see a kind of a slowing tail in the last year and definitely in the first quarter. We think second quarter reflects a little more of a quarter... business, business as usual approach. We're keeping a close eye on inventories above the... the big retailers... Staples, Office Depot, the like, but of course we also have the back-to-school season here in September as well. But we do keep a very close eye on that. And as one, we have to be just a little careful on any given month, any given quarter within the consumer business because we do fall a little bit out of sink with especially the retailers. Yet, I'd also say that I think versus the lot of the other suppliers into the consumer business, our team has continued to do marvelous job of new products and penetration programs across the board. So, we continue to gain business every quarter.

George W. Buckley - Chairman, President and Chief Executive Officer

You would hear, Scott, you heard Pat mentioned earlier that in the Filtrete business, sales are up 75% and what a lot of our customers have been doing is expanding their presence of 3M products, dispersing in some cases other products, so, we would be very successful in gaining share here. And it's really been the innovation taking those best technologies and innovating into new products that pull that kind of a thing off. And this has been pretty consistent across the vast majority of our retail customers. So, we have done well, simply a better, should I say simply because we would be penetrating with new products and it's the innovation, the differentiation that again it's getting that kind of edge over the competition and the power of 3M brands.

Scott Davis - Morgan Stanley

Fair enough. Thanks, guys.

George W. Buckley - Chairman, President and Chief Executive Officer

Thanks, Scott.

Operator

Our next question comes from David Begleiter from Deutsche Bank. Sir?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Good morning, Dave.

David Begleiter - Deutsche Bank

Good morning, hi. Comment on what you are seeing in Europe, any signs of slowing?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Dave, Pat here, good question. I would say that our... the large Western European markets have performed similarly for both the first quarter and second quarter. No, no noticeably... no noticeable change. You, definitely worse in the Spain, Italy, part of Western Europe and probably the UK. The continent has remained low single-digits for us. So, that piece of the business has remained solid for us. Central Asia remains very, very strong us. We haven't seen any impact there at all or the Mid-East... no noticeable difference between Q1 and Q2.

David Begleiter - Deutsche Bank

Okay. And just on Health Care margins in Q2. They were down versus Q1. What drove the decline?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

First of all, I wouldn't worry about it. If I look at the year-on-year results strong double-digit growth both top and bottom line, that business will operate in the 28% to 29% margin range, Dave, in any given quarter. We happen to invest a little more in marketing activities in the second quarter versus the first quarter, which is gone but a normal pattern for us.

George W. Buckley - Chairman, President and Chief Executive Officer

So, there is nothing for you to be worried about, Dave, there is a great business, seems to be growing well, continuing innovation, especially in dental, very, very strong in dental and the orthodontics, sort of subcomponents of that, just doing extraordinarily well. So, nothing for you to be worried about.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Hey, Dave, the other thing, and I guess in for everybody just to remind you that in the second quarter, we have a larger impact of stock option expensing sequentially, Q1 to Q2 because our brand, Dave, is in the second quarter. So, a retirement eligible, where we have the both retiree eligible people is just a kind of peaks in the second quarter. So, all of our businesses sequentially, Q1 and Q2, have a little bit of a hit, I think on a company basis, its worth about half a point of margin.

David Begleiter - Deutsche Bank

Okay. Thank you very much.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Thanks, David.

Operator

Our next question comes from Jeff Sprague from Citi Investment.

George W. Buckley - Chairman, President and Chief Executive Officer

Good morning, Jeff.

Jeffrey Sprague - Citigroup

Good morning, everyone.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Good morning, Jeff.

Jeffrey Sprague - Citigroup

Hi, just a quick follow-up on the corporate for I guess my questions are... Pat I thought the swing from negative $15 million last year in Q1 that was slight positive incorporate in Q1 this year with pension, but we've taken another step up to a bigger positive incorporate. Is there something else going on there?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

It includes the pension, it also reflects some of the cost efforts we have for some of the staff activities here. As of course we anticipated where the economy was going, we have started to streamline even more of our overhead costs here in the center. And part of that flows through that corporate and unallocated piece as well.

Jeffrey Sprague - Citigroup

Could that be falling through as a negative not a positive?

George W. Buckley - Chairman, President and Chief Executive Officer

No. It was a positive... it's a positive, where we'll take costs out, Okay, it obviously is a positive from the income standpoint.

Jeffrey Sprague - Citigroup

And so, it's the reflection of actions you have already taken. Not a new action?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Right. Yes. We fixed, we've sort of the fixed the amount we charge to the businesses, and if there is an over absorbable, to put it in corporate.

Jeffrey Sprague - Citigroup

Okay. And George just a little strategically, actually around HighJump, I don't remember that was your deal or not, but it wasn't very long ago that it was bought, But, whether you were at the helm for that one or not, I kind of thought conceptionally and strategically you had been thinking about kind of a software and electronics type overlay, where you could across the businesses, is that still the case? And if so what was it above this particular asset that just didn't hit the mould?

George W. Buckley - Chairman, President and Chief Executive Officer

That was...

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Let me try to handle the historical piece of this, okay, and I'll let George kind of deal with, kind of the future. George was not here when we bought HighJump, I was... it was a 2004 acquisition that we made in our Industrial business. And as we're trying to get out a space where a lot of our customers had some significant warehouse management type issues, we thought we could incorporate it into our many of our industrial offerings and that we basically dealt with almost all industrial customers. And actually it started off reasonably well, But, as you got into it, it became very obvious that there were some a lot bigger players in that space that we just could not compete... we didn't have the scale to compete head-on-head with the likes of SAP, Oracle and like as they decide to enter that space as well. It was a, we thought it's worth a shot. We, eventually it didn't pan out in the Industrial business, we moved it over to the Safety and Security business as part of our Track and Trace efforts to see, if we could get some traction there, and realistically it didn't fit kind of our long-term... long-term strategy there and there is enough interest in the market that we're able to find a buyer for it, albeit at a loss. So, I'll let George kind of handle the future piece.

George W. Buckley - Chairman, President and Chief Executive Officer

On the strategy, Jeff, it's true, we have aspirations to move towards some more having trying to content in many of our products with where it's appropriate. But, I think it's a sort of secondary strategy. We clearly have those upfront in central, invest in the core, invest in International as the big lead dogs in our strategy. So, all that... as we invest in our electronic things, it will only be at the margin. So you shouldn't see this as any great strategic piece, Jeff, and certainly as Pat has outlined and explained, I had nothing to do with HighJump.

Jeffrey Sprague - Citigroup

And then, can you give us an update on what you're kind of expecting for restructuring over the balance of the year, kind of in the context of the $0.02 that you called out here in the quarter. And I guess, as part of that, it's becoming quite normal for companies, just to kind of absorb that in the pace as you go and continue to march, just what's your philosophy on that going forward?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Well, we will continue to assess the business, the business needs. We talked specifically about the Optical, the Optical one, we will continue to assess really in a couple of different areas as we look at our supply chain strategies over time. We may have some needs to do some restructuring, but don't think a massive destruction, again it's more of a kind of what one-off situation.

But we will continue to assess our kind of our resource levels. We're currently doing that here in the U.S. to see if we'd have a need to do to do something. So, we will continue to look at this on the kind of a quarter-by-quarter basis. Looking at our long-term needs, as well as kind of what the short-term opportunities are, but don't expect anything large scale, we will take a charge here in the third quarter for the Optical correction and that will both be people, as well as around a few facilities that we have. We will more than likely have some offsetting asset transactions going the other direction. So, in the third quarter, we will have a few things probably going both directions probably some asset disposals, as well as some further restructuring charges.

George W. Buckley - Chairman, President and Chief Executive Officer

That's the policy we follow, Jeff. We've tried for the menu, you can't over synchronize these things. It is whenever we've done these restructurings to the extent that we can, and to the extent it makes sense, we've tried to synchronize them. So, you had an offsetting gain to cover the loss. And it's just in all companies, it's just an outgoing tweaking assessment of efficiency and productivity, assessment to market conditions and taking appropriate action as you go forward. But, generally speaking if you, for the most part see, compensating offsets in the round.

Jeffrey Sprague - Citigroup

Thanks a lot.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Thanks a lot, Jeff.

Operator

Our next question comes from Shannon O'Callaghan from Lehman Bro.

Shannon O’Callaghan - Lehman Brothers

So, on operating margins, can you just talk through some of the businesses in the second half? What do you expect to get better sort of second half versus year-over-year. I mean you had margin declines 1Q, 2Q, there has been a mix in that to get to flat up 100 basis points, we have to you know start showing improvement in second half, of what businesses do you expect to drive that?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Shannon, I wouldn't' t read too much into we're running what 22.8% year-to-date. We've kind of said 22.5% to 23.5%, I don't see that as being a kind of a significant change. So, second quarter as I mentioned we had a little bit, we have a kind of an unusual, about half a point move because of the recognition of our retiree stock option, obligation. Well, other than that, I don't really see a significant change of Q3 has a tendency to maybe be a little bit better, and then Q4 has a tendency to be a little bit down, okay, and somewhere in the Industrial related businesses. But I don't see any [inaudible] going to be unusual, unusual this year.

Shannon O’Callaghan - Lehman Brothers

And, Pat you mentioned that, 28% to 29% for Health Care, I mean first quarter, it was kind of, I guess, an outlier, I'm not sure what drove an unusually high end result there, but is that kind of the right range we should think about Health Care?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes. I would say in that, the 28% to 29% range, I think is a legitimate range. In any given quarter, it even may be a point or you know a point higher or lower depending upon, what we do. As I mentioned the second quarter happens to be that we have a larger portion of some more discretionary marketing programs going on, sales may or may not exactly fall in that quarter. So it's probably a normal range.

Shannon O’Callaghan - Lehman Brothers

And just on Display, I mean you mentioned the Optical sequential margin improvement. Can you guys feel more confident that... since you had a little bit up sequentially here in D&G that even though the... maybe the market dynamics haven't bottom your margins have?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

I would not go as far to say that the margins have necessarily bottomed in D&G. We feel good. We're fighting this battle that we had, kind of a stable margin for quarter-on-quarter. But, I'm not ready to say that that is going to stay there, okay, for rest of the year. That obviously won the businesses that possibly could see a kind of a margin drop here of another point or two at the end of the year.

Shannon O’Callaghan - Lehman Brothers

Okay. And just... last one from me is, given the movement in this corporate line. I mean, can we get a guidance number for that line, it's been a little tough to model where that's supposed to come out this year?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Right, I think you can take, my simple model would be, maybe take, Q1, Q2 average them and use that for Q3, Q4.

Shannon O’Callaghan - Lehman Brothers

Okay. Thanks guys.

George W. Buckley - Chairman, President and Chief Executive Officer

Thanks, Shannon.

Operator

Our next question comes from Steve Tusa from JPMorgan.

George W. Buckley - Chairman, President and Chief Executive Officer

Good morning, Steve.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Good morning, Steve.

Stephen Tusa - JPMorgan Chase & Co.

How dilutive was Aearo in the quarter? Was there some dilution there?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Well, actually we are very pleasantly pleased with the start-up here of Aearo. Originally, we said that would be about $0.02 dilutive on an all-line basis with product closer to $0.01 dilutive. We said we have $20 million of one-time charges in the second quarter but actually has superb operating results both top and bottom line for the whole quarter. So really nothing, to of a significance at the corporate level. I mentioned that the sector of the segment level are probably impacted, their operating margins by about two points in the quarter. But we... kind of... all that into the company that... it's going to get... just obviously muted at that point in time. So, I wouldn't say that that was a big impact.

Stephen Tusa - JPMorgan Chase & Co.

Okay, and then as far as the plants that you're starting up around the world, are those going according to plan and are they still operating at losses, are you loading them? I mean, just give us an update on the various plants around the world of how that's going.

George W. Buckley - Chairman, President and Chief Executive Officer

Steve, they're mostly finished down. We're right at the back end of that construction. The vast majority of them went absolutely perfectly. There were a few that got permitting delays in the locations where it's a little more challenging in China and Russia for example, but nothing of very... of a material nature. And the [inaudible]. The ones that we completed really like the one in Korea doing extraordinarily well, and we're probably at a point where we will see a sort of a tipping point soon in terms of contribution in the next quarter too. So seems to have gone, they seems to have gone, I won't say without the hit because that's... as always abating, tempting providence. But it's an operational execution piece of 3M, it's just flipping superb frankly speaking to watch. So, no costs are concerned, everything is running into plan, and an over time those things will load up over time those things will load up and begin to make a bigger contribution to 3M both on sales growth and operating income.

Stephen Tusa - JPMorgan Chase & Co.

And then there are no problems with regards to external factors like demand, where you're having trouble filling these things up and getting them started to appropriate volumes?

George W. Buckley - Chairman, President and Chief Executive Officer

No. In fact, in some cases, Steve, and the ones [inaudible] and the ones on the respirators , we would have been a real pick had we not had that capacity, it's a counter. I mean, the only one way you could point some criticism at is the optical factory obviously there is a consequence of the transition that we saw. They've not been loaded unless we have these but, all in all, it seems it worked out to be a pretty good strategy.

Stephen Tusa - JPMorgan Chase & Co.

Great, thanks.

George W. Buckley - Chairman, President and Chief Executive Officer

Thanks, Steve.

Operator

Our next question comes from John Roberts from Buckingham Research.

John Robert - Buckingham Research Group

Hi, guys.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Hey, John.

John Robert - Buckingham Research Group

Could you discuss the sequential performance in Optical? I know TVs have a seasonality because, but it seemed that seasonality is kind of a secondary factor right now. So, have you seen the bottom in profitability even though you haven't... the bottom revenues and would you expect some sequential performance as we go through the rest of the year for improvement?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes. If you look at sequentially, John, most of the top-line reduction, Q1 and Q2, was in the TV.... is in the TV segment. The other businesses seem to perform about at the same level from the top-line. Bottom line, I think you could probably... you've seen the kind of a further reduction in Optical profitability, Q1 and Q2. That's still a... fall-off a little bit here further in Q3 and Q4, but we are a lot closer to the of it right now.

George W. Buckley - Chairman, President and Chief Executive Officer

You heard me, John, say earlier that sales have fallen by about... in that segment... in that LCD TV segment have fallen by about 66% of what they were a year ago and profits have fallen by about 80%. So you can sense that, even if we lost all of the TV segment, which I think is unlikely, that we are relatively close to the bottom year, I think, it's an educated guess in some sense, but I think that there'll always be a portion, this is what we see, there will always be a portion of that market, well, we won high-performance televisions. That will give you something of the order, 5% to 7%, maybe 5% to 9% attachment rates. So, I think the bottom is with inside. I'm not making any predictions here, but there is gaining momentum in the interest in energy, and of course one of the way that you can use our films is to take a TV or monitor or even for that matter a notebook and takeout lamps and use the films to brighten them. So you end up using less energy, and that factor is now gaining a lot more interest from the set manufacturers than it once did. So, all I'd say is there's a bit more to go would be my... my estimate, a bit more to go, but we're getting close to the end, and I'm hoping that by the end of '08, we're going to be past all or most all of this, and if there is any bleed-over into '09, I think the bleed-over should be relatively small.

John Robert - Buckingham Research Group

That is my follow-up question, but can you point to any low-end TV products in the U.S. that advertises lower energy consumption, but in some place you can point out to show that the TV customers... but if your TV customers would think that this is an important consumer-marketing factor?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

At this point time, I don't... I can think of one. John, we... they are in the notebook space, okay? But not in the TV market.

John Robert - Buckingham Research Group

Right. Could that be... plug in?

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes.

John Robert - Buckingham Research Group

Okay. Thank you.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

But it is in an emerging issue, John, it may not be there today, but I do think this will get more visibility as time goes on.

George W. Buckley - Chairman, President and Chief Executive Officer

John, just it won't keep you on the phone call long here. But there is technology that we have today that will cut the energy usage in a television by 50 in a big set even by as much as 70%. It's here today, you can have it today, at some point the market is going to get interested in that and at relatively little or no premium, I think the forces are aligned over the coming months for that to get some momentum, we'll have to see.

John Robert - Buckingham Research Group

Are there any government movement to put energy ratings on TVs like you have on refrigerators and air conditioners?

George W. Buckley - Chairman, President and Chief Executive Officer

Yes, the EPA has this energy star rate when they put on TVs, whether the EPA or anybody else in the State of California or perhaps the European Union will take any action remains yet to be seen. But, of course if they were to choose, if they chose to get involved, that would be a real catalyst for some growth in films. And actually, in the end, due to more environmentally friendly televisions.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

You know, just as surprising we've actually seen it in the places like China, okay. China is taking an initiative to, especially within the government procurement offices of mandating buying energy efficient electronics and the like so. There is a momentum there.

Operator

That concludes the question-and-answer portion of our conference. At this time, we will turn the call back over to 3M for some closing comments.

Patrick D. Campbell - Senior Vice President and Chief Financial Officer

Yes. This is Pat. Thanks for joining us this morning. We look forward to seeing you all in our September 9th Investor Event and have a good rest of the day.

George W. Buckley - Chairman, President and Chief Executive Officer

Thanks a lot, everyone. Thank you.

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