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3M-Decatur optical film scrutinized
Company's plummeting
stock creates uncertainty

By Eric Fleischauer 340-2435

Even as 3M sinks $120 million into its new optical film plant, an investment analyst asked Tuesday if it's time for the company to sell the business.

3M Chief Executive Officer George Buckley said no "for sale" sign is in the works, but 3M's fourth-quarter earnings conference produced many questions about the difficult market conditions for 3M's optical film production, centered in two Decatur plants, one still under construction.

Optical film is 3M's growth industry of choice. Manufacturers use the high-tech plastic sheets to enhance the brightness and image quality of displays for mobile phones, handheld computers and, most problematically, large-format liquid crystal display TV screens. The sheets also reduce energy usage.

Concerned about quarter-to-quarter volatility in optical films, one analyst was blunt: "George, why not just sell the business?"

Employees not reassured

Buckley's initial response was not reassuring to Decatur employees: "As you can imagine, we've been looking at those sorts of things."

Decatur's problem has been its yields, which have been hurt by 3M's effort to produce more large-format sheets used for LCD TVs. Those sheets have been beset by blemishes.

If the plants were producing nothing but small screens used in handheld computers, the occasional blemish on the 80-inch-wide production sheets wouldn't be a big deal.

But when the end product is a 72-inch-wide film for a large-screen TV, the problem is more significant. A microscopic blemish dooms a large portion of the expensive sheet. Yields are improving, but in early 2006, they were as low as 10 percent. Low production yields mean profit margins for large-screen TV film are much lower than for small-screen devices.

As one finance officer explained in the analyst conference, "The TV mix will continue to become a larger and larger percentage of that business. They (TVs) have a lower margin. As TVs continue to expand, the margin percent in that business will probably continue to come down."

Buckley interjected, though, saying that developments at the Decatur plant give hope that profit margins will not keep falling.

"We have some experiments going on right now that could possibly lead to lower manufacturing costs of these products," Buckley said. "I think we have the technological means now to help support and underpin these margins not going down very much more."

Part of the problem is that optical film prices are going the wrong direction. 3M had to reduce prices in October in the face of intense competition. Buckley, though, said he will persevere.

"It's been a great growth business. It's formed many other businesses," Buckley said. "While you've not seen many of the new products that are coming out (as outgrowths from optical films), there are lots of things being created that we believe in due course will provide new platforms going forward.

"I want to be very careful not to kill the golden goose too quickly."

3M struggled by comparison with Corning Inc., which makes large-screen glass TV screens. Corning's presence looms in 3M's pricing scheme. Increase film prices too much, and TV manufacturers might switch to glass or other film alternatives.

Corning last week announced its market share was substantial enough that it would stop dropping prices. 3M said Tuesday it was not ready to take that step.

"We're by far the most powerful manufacturer in that segment," said Buckley. "What we want to do is keep in mind that we have customer relationships to build, and that there are substitutes (they can) pick. We have to walk a very fine line — an interesting tap dance — in this industry. It will be interesting to see if Corning is successful or not. God bless them."

The net result for Decatur is that its production volume is increasing "in the double digits," said an official, but its revenue is increasing only by single digits. 3M is producing more, but competition is forcing it to sell film at lower per-unit prices.

Buckley, though, spoke highly of Decatur's optical team.

"The optical system people are an absolute joy to behold," he said. "They are such incredibly creative people. They are masters at customizing solutions for emerging issues for the set manufacturers."

The company has 780 employees in Decatur averaging about $50,000 a year in wages, plus a daily count of about 250 contract employees.

The market was unhappy with 3M's report. By close Tuesday, 3M's shares had dropped 5.4 percent, to $74.70, on the New York Stock Exchange.

Net income increased to $1.57 a share, from 97 cents a year earlier, assisted by the sale of 3M's pharmaceutical division. Revenue gained 8.6 percent to $5.78 billion. Most of the good news, though, resulted from one-time gains from sale of its pharmaceutical business.

The company said in the future it would provide annual earnings guidance, but would no longer provide quarterly guidance.

The company was hurt by stalled U.S. automotive and housing markets, which are major consumers of 3M products.

Operating profit dropped 21 percent in the unit that includes Decatur's facility. 3M said optical film demand — heavy before Christmas — fell in late December. Almost half of sales were for the lower-margin large format LCD TVs.

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