3M Company (MMM) Earnings Call Transcript & Summary

Thank you. Great. Well, welcome, everyone, to this fireside chat. It's my pleasure to have next Mike Roman, Chairman and CEO of 3M.

Mike, there's obviously been a lot going on at 3M since you became Chief Executive in 2018. Maybe just discuss sort of how you see things for 3M right now starting out the year.

Yes. So maybe just a little bit of introduction. We're expecting, as we talked about it in our Q4 earnings call, a return to growth in 2020, top line organic local currency growth with some help from acquisitions as we go through the year, leveraging it into EPS, strong EPS growth, continued focus on delivering strong ROIC and cash flow. And I'm encouraged with what we were able to do against some challenged end markets in 2019, putting a focus on that, really getting in line with lower growth challenges from those end markets and focusing on delivering that strong cash flow, a record $5.4 billion in 2019. So this gives us a good position to really turn to growth this year. We made good progress on our other priorities, portfolio and managing our portfolio, moving that in the right direction, taking other big steps in our transformation efforts in 3M, our innovation moving ahead and driving growth in new priority growth platforms. And people and culture, such an important part of what we do. We've -- we're a science-based company. We don't go anywhere if we don't attract top talent around the world. And so made progress on that. We come into the year focused on customers, confident that we can drive that return to growth and ready to leverage 3M's unique technologies and manufacturing, global capabilities to do just that. So happy to go anywhere you want to go from within that introduction.

Sure. Maybe one aspect to follow up would be around -- you announced a reorganization, a new global operating model a few weeks ago. Maybe just help us understand what the time line was for the development of that. You had the resegmentation of the segments about 12 months ago. Did one lead to the other? And maybe just give us some context about this latest reorg.

Yes. I'll start, maybe take you back to November of 2018, our Investor Day. We laid out what we were going to do in transformation to help deliver improvements in margin. And we said 200 to 300 basis points of margin improvement over 5 years, and we had things that we were driving to do just that, transforming 3M around new capabilities, digitizing the enterprise. This was in mind. We saw, as we've been implementing the transformation, deploying new capabilities around the world, we recognized that we could take greater advantage of it in the way we operate it. And we made the decision and then set about really putting this in place to align around our go-to-market models. We take our technologies, manufacturing capabilities into attractive markets, drive innovation. And we are in industrial marketplaces and B2B through channel, OEM direct businesses, health care models and consumer models. So we took the step -- the 5 to 4 alignment last spring wasn't a shuffling of the organization as much as it was aligning around go-to-market models. And then through the rest of the year, we've been working on this next phase of transformation that I talked about in the Q4 earnings call, which is to really realign the company around those go-to-market models, take advantage of business transformation, streamline the company focused on driving greater growth with our customers and greater efficiency. We have historically managed our businesses with both a global business, portfolio management and a country-level business leadership across the enterprise, and this helps streamline that. In the history, it was difficult to manage globally some of our businesses when we had legacy IT and ERP systems in every part of the world. Deploying the Business Transformation capabilities has not only enabled us to have the ability to manage globally, but it's helping us to digitize, streamline, change the business processes. And this is the next big step of that, something we have been planning for, something we worked throughout last year. We -- and we made this -- took the steps to implement it as we went through 2019. We put our manufacturing, supply chain and customer operations organization together effective in Q3, and we hit the ground running with that. And we've made the leadership changes and really deployed the changes in people as we went through Q4. So we are talking about something in Q4 that we are already operating. We launched it January 1. The restructuring charge that we took along with it is really to help enable us to get everybody aligned to the new business processes globally. As opposed to doing that more slowly over time, we saw an opportunity to go directly there. And it's not a -- it wasn't a comment on an outlook for the market. It was really enabling us to really start operating this in the way we intended across the world.

And are there learnings on that point from some of what happened with Business Transformation or maybe the restructuring that was maybe top line-driven a year ago? There are things maybe you are doing differently or more of with this U.S....

Yes. The -- maybe start with that restructuring in Q1 last year, executed in Q2. That was market-related, economic-related. So we saw a big downturn in 3 markets, about 30% of our revenue, automotive electronics in China as we came out of Q1, and we had to get aligned to that. We had to take action, and that's what we've done in downturns in other markets and in recessions. And so we took the restructuring charge. We aligned our costs. We aligned our production plans. We really got better positioned for the outlook. We saw that downturn persisting through the year and executed against that and executed it within one cycle of our business. Within about 90 days, we had fully executed that. And so that was great to see. It got us well positioned, helped us deliver on that cash flow, helped us control kind of what we could control in the face of those challenged markets as we went through the year. So that was different. That was a business cycle-related, market downturn-related alignment of costs and operating plans. Then the one at the end of the year was really about the transformation journey, taking the next step to streamline. Now it has benefits in efficiency and productivity for the enterprise. We are simplifying globally our structure. We are taking the next step. We've been doing some of that as we've gone along. One of the regions that had taken some of the first steps was Europe, and we've been talking over the last couple of years about our efforts to take Europe, which had been our lowest operating margin region of the world, up to 20% as the target that we had set forth by 2020. And with these changes and with this plan in place, we're on track to do that. So that is a reflection of some of the benefits we start to get from that. There are other things that help us in Europe as well, but the Business Transformation has been the primary driver of that improvement.

You mentioned that the -- this restructuring is -- it's very different from the one a year ago because the top line environment is a bit more stable now. Maybe just give any comments you can on that organic sales environment today. And maybe within China itself, local demand but also your own production step-up after the virus and new year, how that's going.

Yes. And maybe I'll frame it kind of pre-coronavirus, how we were looking at the year and then we'll lay in how we're thinking about coronavirus-related. We started the year, we talked about a return to growth, and it was looking at our markets around the world, those 3 markets that I just talked about, more stabilization there. We -- we're actually looking at China as low to mid-single digits growth for the year. A little bit of a softer start in China, primarily related to automotive industry. We see build rates in China even coming into the year down significantly in first quarter. But electronics getting a little better, broader China seeing some improvement. We expected electronics -- we saw some early signs in semiconductor manufacturing, some positive signals around consumer electronics. So there, we saw some improving -- at least stable to improving. Automotive outside of China, globally, I think build rates are projected to be slightly negative. We might be a little more conservative on that in our outlook. But broadly, in the enterprise, we saw growth, growth being led by our health care business, and that was where we guided the strongest growth. Our Consumer business was also stronger than the enterprise on average. Our Safety and Industrial business kind of right down the middle of the enterprise. And Electronics and Transportation -- our Transportation and Electronics business is kind of -- a little bit of uncertainty, in minus 2% to plus 2% range as we came into the year. Coronavirus, I would say that's created more -- a little more uncertainty in the near term, though we have really 3 approaches to what's going on in China with coronavirus or COVID-19. The first is we employ 8,000 people in China. So we've put a big focus on our employees, initially to make sure we knew where everybody was and that they were safe and we could account for our -- all of our people. And then it's about getting back to work, how do we manage that. Coming out of the extended Lunar New Year shutdown, we are operating our plants, and we're bringing people back to work, following protocols, contending with things like your head office not having HVAC running. So how do you manage working in those environments or working from home more? But we're -- so we're starting up. So our employees are a big part of that because that is the foundation for what we do in country. Then we've got the demand for our respiratory protection, some of our health care products. Just we are ramping our production to full capacity in China and globally to support that. And so that's been a big focus. The demand is outstripping capacity right now, and we're working 24/7 to ramp up and be able to meet as much of that demand as we can. And then we've got the rest of our business and what's happening in our customers as they start their production again, what's happening to their demand, how is it going to impact Q1, how do we see it impacting the total year. And you see some signs of impact on Q1 as they -- they had an extended shutdown. A number of companies have come out and talked about demand, cautioned around demand and even softer demand in Q1. We've got the respiratory and health care businesses offsetting some of that. So it's a little early to really see the total impact on Q1. It's a little harder to look through the year. If electronics is impacted or automotive is impacted, does it recover? It could still be kind of in line for the total year. So it's early to really have a clear view of that. But in the coming weeks, we'll get a better view of that.

And if you think about inventories, I guess, through '19, you had underabsorption in your gross margin, some sort of channel partners destock and your own underproduction internally at 3M. Where do you think we sit in that today?

Well, you highlighted a couple of the challenges we faced, which goes up in our operating margin in 2019. Certainly, softer volume declines organically. We're also -- driving a focus on cash flow, really managing the other side of some of the big go-lives we had in our ERP deployment. We had inventory kind of safety stock in place. We had a focus on taking inventory out. That also impacted margin. So we took out $370 million of inventory, taking our days of inventory outstanding down significantly in the year. We also took restructuring, which impacted margins in 2019. And then we had acquisitions, significant acquisitions in health care that impacted that margin. So there were definitely some things that impacted and we -- different than maybe past slowdowns, we also didn't see a big benefit in raw materials. If you think back to 2009, our oil and gas, you saw raw material prices coming down at the same time. But that wasn't the case here as you had trade and tariff -- tariffs, in particular, in place. So that didn't give you a help as these markets softened, and you didn't see any kind of raw material benefit. So that was kind of the '19 foundation. As we come into this year, we see volume returning to positive. We are going to manage -- continue to manage inventory but not take it down to the degree we did last year. We've got those now becoming more tailwinds for us in our EPS, and the restructuring becomes more of a year-over-year benefit. We have other headwinds that, I think, you kind of net out against that, we have discussions around that a lot in detail, but it's -- we didn't pay a lot of variable comp in a year like 2019. We expect to in 2020, and we've got some pension payments that will -- that cost to 2020. So it's kind of the way to look at the margins in the margin walk, the EPS walk as we come into 2020.

The inventories and so forth as a whole, do you feel comfortable with today in the...

Well, I'm pleased with the progress we made in 2019. It was -- it actually reflects pretty well on that transformation step that I talked about. We've put together -- in the second half last year, we put together our enterprise operations organization, manufacturing, supply chain and customer operations end-to-end, leveraging the new transformation capabilities, digitizing that, automating it. It really put us in a position to -- and we saw a benefit in a couple of areas. One is inventory. We got after inventory in a way that was -- we wouldn't have been able to get there as directly as we did without that capability in place. And at the same time, we improved our service levels to our customers. Not only do we improve them year-on-year and as we went through the year, but better than our legacy performance had been. And this was, I think, a good testament to the changes we're making in Business Transformation. You ask your customers to do quite a bit in a change like this. So the way they interact with you, the systems, the portals, they're different. We're adding capabilities. We're working with them to help them through the change, and now delivering improved service is what we can really get back to them, and it was good to see the progress.

On the operating margin, you laid out 15, 16 months ago that 200 to 300-point expansion. Given the restructurings since then and now in the next 6 months, your revenue line will return to growth. What kind of operating leverage or incremental margin do you think 3M could generate as you head towards that 200 to 300 points?

The 5-year plan that we laid out in November of 2018 had that margin improvement, had some other parts of it, notably growth, that the first year didn't go according to plan. And so we -- as we came into this year, the question is, what do we -- how do we think about that longer term? And we put the focus on 2020 that we are going to deliver on 2020. We're going to drive this growth. We're going to drive this leverage. We're going to drive the cash flow targets, and we'll benefit from some margin improvement. And as we were just talking about, it's part of that plan in 2018, was to get the Business Transformation investments to drive a big portion of that margin improvement. And that is, in fact, what will help us as we go through 2020. Beyond 2020, updating our longer view of margins and the overall plan, we are planning for an Investor Day later this year, and we'll lay out an update more broadly beyond 2020.

So when, let's say, you see, I don't know, 2%, 3%, 4% core growth later this year or '21, should we see operating leverage or an incremental margin of sort of 40% plus? Is that a reasonable -- yes, in the context of your gross margin being close to 50%?

Yes. I think in round numbers, we've talked around 35% historically. What we do in margin improvement will benefit that as well. So it's -- that's -- so this transformation investments, some of the other things we've done in portfolio and even driving some of our operational efficiencies and digitization, those are all going to be contributors to that.

If you think about the portfolio right now, we've announced a couple of divestments. Drug delivery is a business that will be coming out of the portfolio fairly soon. Beyond that, I guess, how radical or large could the portfolio pruning be? And I guess when you look across the whole portfolio, are there certain pieces that you think have more structural challenges than you might have thought 3 years ago?