3M Company (MMM) Earnings Call Transcript & Summary

Hi. Good morning, everyone, and welcome here to day 2 of the 8th Annual Credit Suisse Industrial Conference. We're very delighted today to be kicking off with the 3M team. With me on the session is Mike Roman, 3M CEO; Monish Patolawala, CFO; and Bruce Jermeland of Investor Relations. Once again, thank you, everyone, for being with us. I'm going to hand the call over to Mike. He has a couple of prepared remarks. And then we'll go into a fireside Q&A. Thanks.

Well, thank you, and good morning, John. It's good to be with you today. Let me open with a couple of comments, starting with our press release that we issued this morning. The COVID-19 pandemic has advanced the pace of change and disrupted end markets around the world, increasing the need for companies to adapt faster. As you may remember, at the start of 2020, we launched a new global operating model. We aligned around our 4 go-to-market business models: our Safety and Industrial business that goes through B2B distribution; Transportation & Electronics, which is a spec and direct with OEMs; our Health Care and our Consumer retail businesses. We also established a new global enterprise operations organization to really manage end-to-end customer service, manufacturing operations and our supply chain. And we implemented a new corporate affairs organization to advance our brand and reputation around the world. This new model has had clear benefits to both 3M and our customers, and we're really seeing that in the midst of COVID. It's all about modernizing how we run our businesses, how we're building the organization for the future, how we're transforming into a more agile, more efficient, and ultimately, a more competitive enterprise. Since our implementation, we're seeing even greater opportunities to further streamline our operations. We have an opportunity to reduce redundancies, simplify reporting lines, really position our businesses for greater growth and productivity as global markets start to emerge from the pandemic. As a result, we are initiating a restructuring that will simplify and streamline the organization across our business groups, functions and geographies. As you saw in the press release, we expect to take a total pretax charge of $250 million to $300 million, with $120 million to $150 million of that in the fourth quarter of 2020. And most of the remaining balance will come in the second half of 2021. These actions will deliver an anticipated annual pretax savings of $200 million to $250 million with $75 million to $100 million in 2021. The restructuring is expected to impact approximately 2,900 jobs globally. Beyond that news of the day, we continue to fight the pandemic from every angle to ensure the safety of our employees, health care workers, first responders and the public. In this still highly uncertain environment, we posted, in Q3, 1% organic sales growth. We continue to deliver strong operational execution and robust cash flow, along with strengthening our capital structure. We continue to innovate for customers and invest in the future for both growth and productivity as well. As you may have seen a couple of weeks ago, we continued to deliver consistent sales performance, with October organic growth up 2% year-on-year. And this was in line with what we had communicated during our Q3 earnings call. And as we have stated, we plan to continue this monthly reporting of sales information through the end of the year to help provide some transparency on our ongoing business performance. As we move through Q4, our value model is strong. And we are continuing to invest in both growth and productivity to lead through the crisis and emerge from the crisis even stronger. So with those remarks, I'll turn it back to you, John, and we're happy to take your questions.

Great. Thanks for the kind of level setting us here on the announcement today. Maybe that's where we start first. So there were also a couple of other things in the announcement that we kind of picked up on. So one, I guess, would you characterize this and it appears it's more related to the business model change than maybe anything you're seeing in terms of end market trends needing to have to get ahead of any kind of sustained softness? And then, I guess, as we think about the payback, right, you gave us the $250 million to $300 million of the cost and the $200 million to $250 million of the payback, not perfectly one-for-one, but just how do you think about that?

Yes. It's good questions, John. And I would say, you're right. The focus and the opportunity really to step into this restructuring that we announced today is really based on what we've done to advance our model -- our new operating model. It's not exclude -- it doesn't exclude impacts from the pandemic. The pandemic has really driven some trends that are forcing companies to adapt faster to really drive changes in our businesses. It's not so much about the economic outlook. We continue to see solid performance, as I talked about, coming into the quarter. It's really about positioning us to lead forward and take advantage of those opportunities we have in our operating model to really streamline the company. And it's about both growth and productivity. It's an opportunity to lead forward in both of those areas. The COVID pandemic does have an impact on our businesses, and so we will leverage that in how we think about where we prioritize for growth and how we really apply the opportunities that we see in our business model, but it's really driven by that operating improvements that we're seeing. Maybe I'll -- maybe in terms of the specific questions around how we think about payback, maybe Monish can make a few comments on that.

Yes, sure. So the way I look at this, John, I think there are 2 pieces when you look at payback. One is the people cost and the other is assets. So in some -- this chart also includes a few impairment of assets. So the combined, I would say, it's pretty much in line with what 3M has seen in the past. Nothing much different.

Great. And then I guess just a housekeeping, you have a history of including the restructuring charges in your earnings. Should we expect that going forward with this charge?

Yes, John. And also no change. That's the policy.

Maybe a more strategic question around the release today. You did identify, I think, it was kind of 5 growth markets that you want to focus on, you touched on a little bit in the prepared remarks. I don't have the release in front of me, but like e-commerce, automotive electrification, right, personal safety. I'd be curious, how did you come to those particular platforms as the ones you wanted to kind of elevate and highlight in the release? And then how should we think about the ones where maybe they weren't called out? Obviously, when I think about 3M's portfolio, you have been on this kind of journey of streamlining bit by bit. Should we think that, that could continue from here?

Yes, John. Maybe to start with the streamlining. The actions that we're taking, that does impact all businesses, all functions, all geographies. We're seeing that with our operating model broadly deployed. We see opportunities across all businesses, functions, geographies. What we called out are areas that we are seeing growth opportunities. There are trends in the middle of COVID, we've talked about these. Trends that have accelerated in terms of digital and digital commerce, but also trends in key end markets that have accelerated under COVID. And those are some of the markets that we called out, personal safety, home improvement. We've been talking about that really all year as we've come through COVID. We're seeing strength in those end markets. We see strength in electronics and semiconductor manufacturing and data centers and factory automation. Automotive electrification, we're seeing strengthening as we come to the second half of the year. We see other areas. General cleaning is another trend that's been strong for us as a company. So those are certainly areas as we move through COVID, and a number of those we see as strong trends longer term. We think there'll be opportunities to continue to take 3M's innovation and drive greater growth in those markets. So we called those out. There's -- I think there are other impacts in the portfolio, we've talked about that as well. We have some of our businesses down significantly, and we've been impacted by the lockdowns in the economy, the impact on certain end markets. We've talked about automotive down significantly in second quarter, sequentially getting better in third quarter. But for the total year, we're expecting build rates to be down quite significantly. It really -- mid-teens for the total year is the projection for build rates globally. So that's an impacted market that we are having to manage through in COVID. And so there's -- we're seeing both sides of it. The ones we called out are really the opportunities we're seeing that are driving some of our overall growth and also trends that we see continuing as we go forward.

Great. And maybe before we have a broader end market discussion, just thinking about the fourth quarter here, you said you're going to continue with the monthly releases. Obviously, we don't have a November release just yet. But anything you would share in terms of kind of the nearer-term trends here in the quarter from a top line perspective? And then maybe the last question kind of about the quarter, but Monish, you guys have a guidance of 21% for the operating line. I think you called out investments or the pace of investments as a way to throttle that and manage to that number. Any kind of update there on kind of the bottom line as we think about Q4 and that margin that you've put out there?

Well, as you saw in our press release around October sales, it trended right in line with what we said at our Q3 earnings call. So up 3% overall, 2% organic growth, right in the middle of what we had called an outlook of flat to low single digits in October. And that was based on how we were seeing markets progress. Not only the markets that I had highlighted that are strong, but also key markets like elective procedures, how is that going to progress. And we've seen that go along pretty much in line with what we expected, that we would see elective procedures down year-over-year, plateauing in that 80% to 90% kind of level versus last year. And that was true for medical elective procedures and oral care as well. So we saw that in October. It was really part of why those sales came in the way they did. And as we sit and we hadn't brought back guidance, we continue to give monthly sales because of the uncertainty we see in the end markets. And with the resurgence of COVID cases, we're watching this closely. What happens to those end markets, what happens to hospital's ability to continue to execute on elective procedures. And so I think that those -- that uncertainty is still there. We'll come back and report on November as we finalize those results. So we'll come back and give you a little more detailed view of that. But it's -- through October, it was pretty much in line with what we were seeing as we were sitting there in the earnings call. Maybe Monish can talk to your question about the margin.

Yes. Thanks, Mike. John, I'll take this in a 2-part just so that we can give you a little more clarity on the quarter. So first, I just want to highlight a couple of things that were factored into our earnings or guidance that we gave in October during our Q3 earnings call. These things are becoming clearer, just so I thought it would be helpful for -- to share it with you all. One is we have finalized the sale of a couple of real estate assets in Asia. That's an outcome of a portfolio action that we took in our closure and masking business in the summer of last year -- of this year, sorry. It will generate a $50 million pretax gain. That gain will show up in the SIBG segment of our business. Secondly, we are in the midst of finalizing our regular actuarial accrual analysis of potential respirator claims and contingent liabilities that extend over multiple decades. As a result of that, currently, we anticipate an increase in our respiratory approval, ranging between $80 million to $100 million of pretax in Q4, which will be reflected in Corporate and Unallocated. For the full year 2020, that respiratory approval charge will be approximately $120 million versus an approximate average of $100 million annually over the past few years. Thirdly, I would say, given our strong liquidity position, we decided to take action this quarter and exercise our option to repay back $1 billion of debt, which is expected to mature in 2021. This will result in approximately $0.01 headwind in Q4, but it will be more than recovered in 2021 through interest cost savings. So I just thought that would be helpful to share some of those items before I go into the margin discussion. So to answer your specific question on margin and how do I think about investments, you're 100% right, that investments was definitely one item that we had factored in, into our discussions in Q4 plus some of these other items I just talked about, which is the actuarial accrual as well as the real estate gain. As Mike mentioned, I would tell you we are still in a very uncertain economic time. Our end markets are strong, but they are still recovering. IPI, GDP, both are supposed to be negative for the quarter. So we'll actually see where revenue plays out for the quarter and that will have a massive impact on what's going on. But as I've said in Q4 -- Q3 earnings, I'll say it again, we will remain extremely disciplined on cost management, but we will invest in areas where we see growth. Mike has already mentioned some of the areas where we see growth. So we will continue to invest in that. We will pull back in areas that we just see slower economic activity. So for example, Mike already talked about where he reiterated personal safety, air quality, home cleanliness, digital, auto electrification are areas that we will continue to invest in this quarter and the future quarters. Also to remind you all, sequentially, Q3 to Q4 is always lower for 3M. Q4 is historically the lowest margin quarter from a sequential basis. Also, Q4 has 2 less billing days compared to Q3. So that also impacts the margin in Q4. And then the last one, as Mike said in the opening remarks, we are going to take a restructuring charge of anywhere between $120 million to $150 million, which will have an impact of 150 to 200 basis points on the margin rate. This item, of course, the last one wasn't factored into the guidance we gave you in October of this year.

Great. Maybe we can keep a discussion around kind of the liquidity profile of the company. I mean, right, post Acelity, I think you've been on this journey of deleveraging, which you articulated at the time of the deal. How should we think about where you want the balance sheet to ultimately end up here at the end of that journey? How much more is to go before we kind of start maybe thinking about kind of more opportunistic deployment of capital via share repurchase or M&A?

I think, John, I would tell you, you're right. We are on this path of delevering, I believe, even before my time. Mike and Nick had said we would go sub 2 on a net debt-to-EBITDA from a leverage perspective. You've seen the team's done a great job. We are below 2 now. We are at 1.8 at the end of Q3. Our goal right now at such an uncertain time is to continue to strengthen the balance sheet. 3M definitely generates. So the model generates good cash flow. So we want to make sure we continue to deliver that, be disciplined on generating cash, disciplined on how we allocate that capital. So our job, we are going to continue deleveraging until we start seeing some stability in the end markets from a pandemic perspective. To answer your question on capital allocation, our 4 priorities. Step number one is we will always invest more organically because we just feel that's the best return. Step number two, dividend has been a big -- is important for our shareholders. We understand that. So our second priority is dividend. M&A, we are always looking for M&A. I don't think we'll see a big transaction like Acelity, but we have a good, healthy pipeline of things that we'll always evaluate, we keep evaluating to make sure that the acquisitions that we do fit well into 3M, add value to 3M portfolio as well as 3M shareholders and that these acquisitions take advantage of the strengths that we have, which is brand, global capability, ability to innovate and our technology. And then the last one is share buyback and that's the way we look at capital allocation priority.

Great. And maybe a question for you, Mike, here around the portfolio. Not asking you to comment on any kind of specific news story, but every once in a while, something does pop up there just kind of given the size of the organization. How should we think about where you are on the journey of reviewing the portfolio?

Yes. John, portfolio continues to be a top priority for us and for me as I look at how we create value. That's really what portfolio is about, is maximizing the value we create for shareholders and for our customers. And we utilize our ongoing continuous view of portfolio to really optimize that value creation. It starts with organic, as Monish says, our first priority in capital allocation and it's our first priority in portfolio. Really looking at what are the most attractive markets we can play in, where can we leverage the differentiated fundamental strengths of 3M to create that value. Where can we create the most differentiated value for customers and shareholders. And so we prioritize those markets for organic investments. We prioritize portfolio for organic investments, first and foremost. We look for complementary M&A to move into more attractive markets, to leverage the synergies of 3M, create greater than the sum of the parts when we integrated those acquired companies. Acelity is a great example where we see attractive markets and opportunity to leverage 3M's capabilities, fundamental strengths. And then we're always looking at where do we have businesses or portfolio that don't align to those fundamental strengths or maybe not in as structurally attractive markets or where 3M isn't the best owner for creating value long term, and we'll take action. We've done that with divestitures, drug delivery recently, telecommunications business, our gas and flame businesses. We continue to evaluate our portfolio in all 3 of those kind of those lenses. And it's something that we know -- the reason it's a top priority, we know it's critical for creating value from the innovation that drives 3M.

Great. Maybe we can shift gear to a couple of your larger end markets, and obviously, understand in the quarter they're under some pressure. But when we look forward, there does appear to be, at least, to us, a nice growth profile going forward. So as I'm thinking about that, I'm thinking about the automotive business, I'm thinking about the electronics business. Clearly, there is enthusiasm around a better build rate next year. I think 3M also benefits from an EV ICE perspective, more dollar content per vehicle. You have that traditional algorithm about growing the builds, right? So I just want to make sure you don't see anything different this cycle. And then I guess on electronics, right, as we think about 5G handsets, right, you've done a good job on your spec-in business. When do we start seeing the sales for those kind of future things flow through 3M? I think there's kind of a couple of quarters you see it ahead of the actual delivery.

Yes, yes. Maybe I'll talk about both of the markets maybe separately here, John. So start with automotive. It's been an incredible year in automotive. We saw build rates down dramatically in second quarter worldwide, mid-45% range build rates. And in third quarter, as I already mentioned, we saw sequential improvement, still down year-over-year. Year-to-date, our performance versus build rates were up that in that range of the 300 to 500 basis points that we've been posting over the last several years where we've been able to outgrow the build rates based on additional spec-ins and bringing our innovation more broadly across makes and models. Automotive electrification has been an important part of that. That's an opportunity for us to bring a broader range of innovation as you look at electric powertrains. One of the things that's common for both electric vehicles and internal combustion engine vehicles is the increasing penetration of electronics in general, which is an opportunity for us. So that's been part of that growth above build rates. And we see that continuing as we move ahead. As I already mentioned, build rates are projected to be down mid-teens for the year for automotive worldwide, but up low maybe single digits as we get into 2021. So the outlook is for an improving build rate. And we continue to expect to be able to drive innovation, new spec-ins and that growth above build rates as we go forward. So we'll benefit from the uptick and sequentially improving build rates, and we'll see an opportunity with our innovation to do even more. On electronics, so just to set the stage, electronics is about a $3.5 billion business for 3M. $2 billion of that is in consumer electronics. The other $1.5 billion is in semiconductor, fabrication, factory automation, data centers and increasingly automotive electrification applications are part of that when we think about electronics outside of consumer electronics. Consumer electronics is down double digits for the year. I think a little better expectations in Q4, down single digits. So it's been a challenging year in terms of consumer electronic build. There's been some bright spots. Tablets and notebooks and televisions have all been positive growth opportunities as we've gone through COVID, but the mobile devices, in general, are carrying that downward trend. Now we've had -- our total electronics business is up 1% year-to-date, and that's really based on the strength that we've seen in the opportunities in semiconductor and factory automation, automotive electrification, data centers. Those have been strong growth opportunities for us as we come through the year. As you turn into 2021, expectation is consumer electronics will get better. The build rates will get better. 5G will promise to help carry some of that forward. There's a year-over-year -- it gets a little better. So the outlook is, I would say, more positive as we go into 2021 and we expect the strength in those other areas like semiconductor fabrication to continue into the new year. So it's getting better sequentially, and then we see a positive impact in the end markets or positive growth in the end markets as we go into 2021.

Great. And I'd like to also have a conversation around the margins as we think about next year. But maybe before that, just because it is topical, just anything that you have line of sight into with the change in the administration around the timing or anything around PFAS or other things that we should be aware of? Or is it still kind of the same as you laid out on the last earnings call?

Well, we continue to manage PFAS based on the 3 principles that I've talked about before, which is based on sound science, corporate responsibility and transparency. And that -- those are really important to us. It's how we make decisions. It's how we lead forward. It's behind the commitments that we make and we have been following through on. And we continue to do that. We continue to follow through on those commitments. Transparency is about keeping as much information as we can in front of our stakeholders broadly, especially our shareholders. And one of the things that we talk about is upcoming litigation related to PFAS. It's -- we had talked, I think, in Q3 that there was expected litigation in 2021, maybe the first half of 2021. Right now, that's been postponed. So there's no scheduled trials in 2021, impacted to a degree by the pandemic. That can change, and we'll keep you updated as we go. We were very clear, I think, right upfront when the EPA announced almost a year ago their plan for managing PFAS. We're supportive of that. We continue to see that as a path forward to have a national approach with EPA leadership. We expect the EPA to continue to make progress on that plan as they move through the transition with the new administration coming in. And we'll continue to work closely with the regulations -- or regulatory agencies as well as our customers and are following through on our commitments that I talked about.

Got you. And then I guess a question around the incremental margins. So I haven't done all the new math yet this morning based on the announcement, but I guess if we could just think about the underlying kind of organic incrementals of the business and come at the question from that angle, I think you've historically said about 30% to 40% is the range that you target. Now when I think about points of inflection, right, so I mean it does appear next year will be up as long, knock on wood, with the pandemic. But what do you need to see in terms of an organic sales growth rate to push you above that range, just given you do have a vertically integrated business model, right? So that organic volume should probably be your best point of incremental leverage. So how do we think about that? What's the governing factor from a growth standpoint to get us in or out of that kind of typical 30% to 40% range?

So John, I would just start first by saying, just a reminder to everyone, our guidance has been withdrawn. So I would like to avoid commenting just on 2021. It's an extremely uncertain environment. So what the team's focused on right now is just get 2020 a strong close. We are working the plan for 2021, looking at multiple scenarios. With all that said, I would say revenue is a good indicator to decide incremental or decremental, that drives a lot of the stuff that we do. But that doesn't take away from the fact that we also drive margin improvement through innovation, through driving the business better through operating rigor, through daily management. So you've got to keep all that in mind. But again, historically, the company has said it's 30% to 40%. I would say that's a good ratio to think about. The question is how much do indirect snap back in 2021 as well as how much investment are we going to make for some of these end market trends that Mike talked about. So in summary, I would say, revenue is a good indicator. 30% to 40% is a good number right now. We'll see how the world plays out in '21 and how much we invest there.

Great. And then maybe if we can sneak one more here in under the wire. It's gotten a lot of airtime, the potential for this paper COVID tests that you've been working with MIT. I don't know if there's anything specific to comment about that, but I do think it's indicative about kind of what some of the things that are special around 3M's innovation engine. So maybe you could comment specifically around that particular opportunity. And then also just anything else you want to add to that as a closing remark.

Yes. John, I would say it's another example of how we stepped up to fight the pandemic from every angle. We often talk about personal protective equipment, N95 respirators when we think of that, but it's much broader than that. There are many areas where we've seen 3Mers step up to help fight the pandemic. One of the areas is the example that you're talking about. This is a partnership with MIT to work on the development of a low-cost, rapid saliva-based test for COVID-19. It actually came out of work that we were doing on a malaria test and bringing some technology to make a low-cost rapid malaria test. When the pandemic hit, we pivoted quickly. Great partner in MIT. We're in the middle of development on that. I don't have a specific update from what I shared at the Q3 earnings call. We continue to work with MIT and other partners on the development and really building a capability, a test that can be accurate and meet those other criteria that we talked about. We're excited about it. It's a great partnership. It's another example of where 3M's innovation can make a difference. And maybe that's where I'll leave you. That's a good closing set of comments.