3M Company (MMM) Earnings Call Transcript & Summary

Chairman and CEO of 3M, thanks, Mike; and Bruce Jermeland who runs IR at 3M. So, Mike, thanks for the time. We're going to obviously have a good Q&A session. For those dialed into the webcast, please feel free to throw a question, and if we have time, I'll see if we can get to those questions. But Mike, I know you've got some opening remarks, so please go ahead.

Yes. Thank you, Nigel, and good morning. Thanks for inviting us to the conference. So just maybe a couple of comments. We continue to execute on our priorities that we called out in our Q3 earnings call. First of those is driving performance throughout 3M, and we drove solid third quarter results. You saw that in our adjusted operating margins and cash flow. We continue to make progress on some of the big strategies that we're executing there. We're progressing with the restructuring actions that we announced back in our Q1 earnings call to streamline our organization, reduce our structural cost, get us closer to customers. We are advancing our supply chain performance, a big part of our focus in driving performance across the company, improving service, driving greater productivity, yield, expanding our gross margins, driving cash conversion, increased cash conversion. And then we continue to prioritize attractive markets for growth and investments in growth. And we have core platforms in safety and electronics, home improvement, consumer. Some of those are seeing some market trends that are not as strong growth patterns, but they are great areas for innovation and long-term growth trends that we participate in. And then we're investing in new platforms, in emerging areas like climate technology, industrial automation and the next generation of electronics. And so you saw that come through our results. We increased our full year guidance for adjusted EPS and for our cash flow conversion range. We talked about our growth. We have been saying our guidance for growth, minus 3% to flat for organic growth. We've been talking about being lower -- towards the lower end of that range, and we came -- updated our guidance to say we'll be at the low end of that range, about approximately minus 3%. The second of our priorities is successfully spinning out our health care business, and we're making good progress there. We named the CEO and the chair for the new company. We also -- subsequent to the Q3 earnings, we announced the CFO for the new company. So we've got the leadership on board moving forward with that, with the progress towards -- for completing the spin in the first half of 2024. And then a big focus for us is managing risk and uncertainty proactively and effectively managing the litigation in front of us. We had two settlements that we announced over the summer. Combat Arms, which is a settlement agreement that was announced in August, parties, the courts, overseeing settlement, we're all working towards full implementation of this. Currently, we received more than 30,000 releases from the Combat Arms earplug claimants. We've resolved all the adverse bellwether verdicts, and we're moving forward with the process to pay the settlement to the early releases by the end of the year. The registration process for claimants continues, and we expect that to be -- anticipate that to be completed by late March and next year. Just maybe a few words on the public water supplier settlement. We remain focused on supporting this agreement. We're working through that, again, with all parties and the courts. We're -- we have a settlement that will benefit the vast majority of public water suppliers in the U.S. This is a broad class to resolve the PFAS remediation for those class members. A final approval hearing is for February 2, 2024. We've got a December 11 opt-out deadline, another step in the process. But through that process through the steps that follow, we'll be working towards that final approval in February. And I would just say we expect to continue to build momentum. We're delivering strong performance and building momentum off of the execution of these priorities. And as we exit the year, we expect to be stronger, leaner and more focused as we go into the next year. So maybe that's a good frame up for the discussion here, Nigel, and I'll turn it back to you.

Mike, you've touched on pretty much every question I had, so thanks for doing everything in 5 minutes that I planned to spend half an hour talking about. But you talked about -- maybe just touch on the update on the sales guide, so at the low end of the range. Maybe any color you can provide in terms of what you've seen out there? And maybe what's driving us towards the low end of that range?

Yes. We talked about what we thought we'd see in Q4 at the Q3 earnings call. And so now 2 months in, I would say it's trending in line with what we expected, what we laid out and just a couple of market indicators. Consumer retail demand continues to remain soft in our categories, the hardline goods, something that we've seen all year. We saw in the first half of the year, a considerable focus on reducing inventory by the retailers themselves. That's more stable now as we come into the quarter, but it's -- the retail demand in that category continues to be soft. Electronics, the end market is stabilizing really year-over-year. We're paying attention to the seasonal holiday demands and watching that closely. Our industrial customers maybe notably have been bringing down inventory levels as -- they have a cautious outlook and also as supply chains perform better, they're reducing their safety stock. They're looking at better supply, so they're able to take advantage of that. Health care is generally stable. We're seeing maybe a little bit of destocking in the biopharma channel. They had significant inventory coming off the peak demands in the pandemic. And so it's as we go through the quarter, pretty much in line with expectations, the way we laid it out previously.

Okay. Okay.

Nigel, just to clarify for everyone, the minus 3% is exactly what we've said in our October earnings call. So there's no change to that. We are going to be at the low end of the full year, expected range of flat to minus 3%. So as Mike highlighted, Q4 is trending right in line with -- 2 months in, right in line with where we thought we'd be. I just want to make sure that's clear for everyone.

Very, very clear. No, that's -- thanks, Bruce, for clarifying that. I just want to double-click on the industrial inventories, because that's obviously a big topic of concern, I think, for some folks out there. So any visibility, Mike, in terms of where we are in that process of industrial inventory correction?

Yes. I would say it's not at the same level, certainly, Nigel, as what we saw in the retail channel as they were trying to adjust for the change in demand and the shift to consumer spending thing from one category. I think the sell-out continues to be in line with expectations. This is really taking advantage of improving supply chains. It's -- we're all doing that. We're putting a focus on our working capital, and that's an important part of it. Having more reliable supply of raw materials, being able to run our production plans according to plan, not having to interrupt those, those are -- everyone's taking advantage of that. Safety stocks can come down, you don't have that variability in supply. So I think it's really more of that playing out. And that's been kind of an incremental process that's been playing out over the last number of months and probably will continue. So it's not a -- I think there's caution so there's no focus on building inventory in the channel, but it's a matter of taking advantage of improving supply chain.

Okay. That's very clear. And then one more, and I promise this is the last question on inventories. So biopharma, it just feels that we've been clear in the inventory for the longest time. And I know it's not a big business for 3M, but again, any thoughts on where we might see the turn in biopharma?

Yes. We were looking at it playing out through this year. I think you're seeing some of the demand in the end markets, not where expected. So in the end, you see that related to COVID products, that was part of it. So I -- we're looking at '24 right now. So we don't have an update for you yet. But I would say, we expected it to play out through the second half. It's something that we -- continues to play out in the fourth quarter. We'll update you on where we think we sit as we get into '24.

Okay. That's very clear. You mentioned supply chain. And maybe just talk about with what happened during COVID, some of the supply chain shock that we saw. Has 3M used this sort of intervening period to realign supply chain? I'm just curious if some of this reshoring that we're seeing, if that's an opportunity for maybe 3M to procure more chips over the medium term from the U.S.? Or I mean, any thoughts there?

Yes. Supply chain has been an important focus. Our manufacturing capabilities, our supply chain, being able to serve our customers globally has always been a strength of the company. In early 2020, right before the pandemic, we realigned the company to a global business-led model. And importantly, we went to a global supply chain model, leveraging those strengths. And as we've come out of the pandemic, we put a big focus on executing that while driving more agility through our supply chain. And it's really -- for us, it's a global supply chain executed regionally. We've built our manufacturing capacity close to customers, to serve those customers. The majority of what we sell in Europe, we make in Europe. Certainly, a majority of what we sell in the U.S., we make in the U.S. and same for Asia, China and other regions of the world. U.S., we actually are a significant exporter given our history of building capacity here. We don't replicate every production capability around the world. So we're a significant exporter out of the U.S., but the rest of the world, building that capability close to customers. So we're there as customers adjust their supply chains, as we've seen electronic supply chain move around Asia, we have had regional capabilities to be able to serve that and we'll continue to adjust. We haven't seen dramatic reshoring in terms of volume and capacity at this point in our supply chains, but there's certainly plans out there. You see it in the semiconductors, you see it in other areas to reshore. So we're in a good position to be able to manage that. It's -- where at the same time, we're simplifying our supply chain to better serve our customers, better align with each of our go-to-market models, our retail model, our health care model, our B2B industrial model, our OEM direct model that we serve automotive electronics customers through. So I would say we continue to see our efforts on improving that supply chain, driving improved operational execution. I called out productivity and yields where that's partly raw material supplies getting more stable. It's a big part of it, what we're doing to execute better across our supply chain. So a leader in overall supply chain, the restructuring actions that we took in first quarter were an important part of really supporting that longer-term plan to just drive this global leaner supply chain structure. So we're making good progress, well positioned for customers as they change their supply chains around the world.

Okay. That's great. I want to touch on restructuring -- the restructuring program. You've got a pretty meaningful program underway right now, $800 million at the midpoint. Sometimes when you're doing these large restructuring programs, it's difficult to get it done expeditiously. So I'm just curious how you're progressing with that program.

Yes. We continue to remain on track, I would say, for what we announced at the beginning of the year. We talked about $700 million to $900 million, about half of that in 2023. And we'll actually go into '25 to complete all of the restructuring, but we're on track for what we had talked about. We've got -- we called out, we've been calling it out quarterly to kind of give everyone an update on how we're progressing with that. And so for Q4, we called out charges of $70 million to $120 million. We've talked about benefits of $145 million to $195 million. We're on track for that. And these are -- reminder, these are actions that we announced in Q1, and they were pretty significant, 6,000 jobs that revolve for the company is about reducing costs at the center of the company, reducing layers of management across the company. I would say, taking a focus on a structure at the center of company in line with the spin of health care is also a big part of it was simplifying our supply chain. So about 1/3 of that focus was on really a bottoms-up what do we do to may make our supply chain more efficient, more streamlined across plan, source, make, deliver. And then there was a streamlining of the go-to-market models. We went to that business-group-led model that I talked about. We learned that we've executed that coming out of the pandemic. And so we took advantage of that to streamline that as well. And then importantly, we made some other changes. We've decided to prioritize markets around the world a little differently. And in 27 countries to date, we have changed our model to partnering with local distributors. And so we've really streamlined that part of our global business. It's about little less than 5% of our revenue, but it's an important focus for us as we think about that restructuring. So I'm confident that we'll deliver what we committed to deliver, and we'll update you, as I said, as we get into 2024.

And this total program, this takes care of the stranded costs from the health care spin, so there's not another program on the back end of that?

Well, there's -- we called it out as addressing about half of what you would expect from stranded costs. This restructuring that was -- especially reducing costs at the center of the corporation, we will manage additional stranded costs as we go through the TSAs, as we go through the TSMAs. We've got that part of supporting the spin successfully. So we will address that over time as we execute those.

So if I take the -- I mean, this is basic math, which is kind of what I'm good at. But the -- if I take the midpoint of your 4Q cost savings and multiply that by 4, and then add in a little bit maybe on top of that for 2024, I mean, it seems like you've got maybe $700 million plus of annualized cost savings in '24. Is there anything that's wrong with that analysis? So anything that goes against it? Because it does look like you've got a significant margin tailwind coming through in '24. And again, I'm not asking for '24 guidance here, but it just seems like you've got a big margin tailwind coming through.

Yes. Nigel, there's other factors that go into how we're going to talk about margin for 2024. And certainly, the restructuring actions are important. And following through and executing those are important, driving the performance of our supply chain, the way I talked about, growth is really important. So again, we're working on our 2024 plan. We'll come back at our Q4 earnings call with more details, and a better answer for your question.

Okay. I'll ask the same question in January.

And Nigel, just a quick item. Relative to the total savings we had laid out, there is some expected investments in those savings. For example, the 27 countries Mike talked about, as we take those markets from a locally 3M served market to more of a distribution market, there's investments we got to make relative to, for example, some IT capability as we transition the business model serving those countries. So -- and those investments will be coming in 2024. So that's why as you think about the cadence of the restructuring and the benefits, there are some investments that we've got to make as we go into '24 relative to some of the changes that we're making.

Okay. Thanks, Bruce. And then just maybe one more on maybe slightly different focus on margins, but productivity, and I'm thinking about factory productivity, which took a big hit during the supply chain sort of shocks that we had. Where are we right now? Where are we tracking them right now in terms of factory productivity relative to perhaps where we were in 2019?

Yes, it's a really important focus, as I said and what we're doing to execute the priorities that are in front of us. And we've been driving improvements, and it's showing up in the operating margin, the adjusted operating margin. I talked about that focus on productivity. So we are driving improvements. And those improvements are coming from like I said, more reliable supply raw materials, but importantly, from what we are doing. We're investing in productivity through greater automation. We're leveraging data and analytics to drive better visibility of our opportunity, a very clear view of where we can drive productivity and importantly, with productivity improving yields through our production lines. And so making very good progress. It's -- we expect it to be part of the momentum that we're going to carry into 2024, and we'll continue to build on that.

Okay. Great. Thanks, Mike. You mentioned -- we touched on the 2 settlements in your opening remarks. I think you talked about the deadline for the opt-outs is next week for the public water settlements. Anything -- any color you can give us in terms of how -- I don't know if you can talk about how that's been tracking, but the confidence in sort of achieving the right level of sort of non-opt-outs, I guess?

Yes, it's something we're engaged with as part of the process. So December 11 deadline for opt-outs, there are other steps that go around that process. Really, what I would encourage everyone is focus on getting to the final agreements dates for the February 2 final agreement date, that's the focus at this point. Because there are steps in the process, and we'll update as appropriate as we go through this. But December 11, an important step in the process, more steps to follow as we focus on getting to that February 2 final approval.

Okay. Great. And then there's a lot of questions around those public water utilities that aren't part of the settlement or choose to opt out. Do they have the option to pursue their own legal claims against 3M? Or are they somewhat bound by the agreements?

Yes. It will depend on the specific claimant situation, but they -- if somebody opts out, they would have the ability to pursue other paths. That's part of the -- it's a class settlement. You have to opt -- you opt out at your choosing, but that's part of what they'll consider. There's also -- just as a reminder, we had -- we've been working through objections from claimants as they work through in understanding the process. So that's an important part of what we're doing, is working through -- helping to make sure we're answering questions, understanding and continue to help people make -- help the claimants all understand the value of the settlement and the path that it represents. And again, all parties the plaintiffs committee, the court, the 3M we're all aligned on this is the right settlement to take forward. So we'll continue to work with claimants around that.

Okay. And then on the Combat Arms, I think you mentioned 30,000 opt-ins at this point. Just out of interest, I mean, is that a good number at this stage of the process? Are you pleased with that number? Because obviously, the threshold for this one is a little bit higher.

Yes. And remember, we have multiple steps that we talked about. We had the bellwether verdicts, which we resolved and paid the settlement on the bellwether verdicts. The next step was these early participation as well as the wave cases. And both of those are in the process of -- the wave of cases are a series of cases that were set up for a trial, and that was part of a step in the settlements. And we continue to make progress on both those. I called out the early -- it's expedited payment settlements that we're talking about because of the numbers that we're seeing, that's something that we anticipate paying by the end of the year. So that's the reason I called it out. That's a $250 million settlement fund that we would expect to pay by the end of the year. We'll continue to progress there. It's March where we get to the final dates for the number of participants that are finalized as well as the -- getting to the levels that are called out in the settlement for the next set of payments. So again, focusing on from the bellwether verdicts to the wave cases to the early releases and expecting to continue to make progress towards that March final date.

Great. Moving on to the health care spin. You said the first half of 2024. Maybe talk about where we are in the process with the SEC, the sort of the private filing process with the SEC. Any steps, major steps that we should be monitoring for that spin? And then we'll go from there.

Yes. I would -- Nigel, I would say we're working towards the first half close that we talked about. It's subject to conditions disclosed in our SEC filings. What I can tell you about our progress aside from that is that we continue to advance the preparation in the business. We're preparing our systems, refining the strategy. I talked about building the team. We also are adding the other leadership positions. We expect to file a Form 10, a couple of months ahead of the spin. And so that will be something you can look for as we move forward. We're operating right now with dual systems to be able to prepare for that. So we're making good progress in the separation preparation. The leadership of the company is in place and making good progress with the team. We announced the new name for the team -- or for the business, Solventum. And so that energizes, in particular, the employees that will be part of that spin. It gets -- makes it a little more real that they're heading towards that. So I think we're getting good energy from the team and again, making good progress on each of those steps. And we'll update you through our filings and as we execute some of those steps in the process like the Form 10.

Right. Thank you. And there's obviously a lot of regulatory approvals required with -- for Solventum as a stand-alone company. You're confident that you can get those in time for this first half spinout?

Yes. The team has been working since the day we announced it in July of '22 They've been working through all the changes that are required through, the system changes, as I said, running parallel systems, standing up the legal entities and working through all the regulatory filings. So we continue to make progress, and we're on track for that first half of 2024 close.

Okay. Great. Just a reminder, we're within 10 minutes of the close here, so any questions for the folks in the audience, please feel free to log those. Maybe think about the 3M RemainCo ex health care, you've had this growth algorithm of 2x global IP. How should we think about the strategic growth drivers going forward? And how do we think about the growth algorithm for 3M RemainCo?

Yes. I talked about in my opening comments too, Nigel, we're investing in areas of strong demand, market trends that are strong, global trends that can leverage our material science and innovation capabilities. And these trends, never has there been a more exciting time for material science innovation. We're focused on investing in those large attractive end markets where we see these kinds of trends. So we've been talking about prioritizing in attractive 4 markets that we have, safety, home improvement, consumer electronics, as I talked about. These are large significant commercial portfolios for us that leverage the material science innovation in really important market trends. And then we've got new platforms in emerging areas like climate technology, industrial automation, next-generation electronics. These are how we invest for growth. We expect to refresh our portfolio and revenue over -- every 5 years as a part of our innovation. Our innovation enables growth for us as a company. It also importantly shows up in our margins and cash flow. Leaders in innovation in their markets, in their industries, they typically lead in margins performance, because your -- it represents the value -- the differentiated value that you're providing for your customers. And then for us as a vertically integrated manufacturer and leveraging certainly a lot of intellectual property in our manufacturing capabilities, we also expect to be able to leverage this to drive good, strong gross margins as well as strong cash flow. And those are the hallmarks of really our growth strategy, is invest innovation in attractive markets where we can leverage our differentiated capabilities, working customers in. I mean our model is we're invested in being close to our customers with our engineering capabilities. Majority of our revenue is specified by our customers, so you can see that strong relationship with something that's differentiated. So it continues to be our focus, and we expect to be able to leverage that to drive that kind of value creation across growth, margin and cash.

Okay. Great. And I do want to come back to kind of growth in R&D and commercialization around that. But does health care really mark the final chapter of the portfolio realignment. So do you think there could still be some work to do beyond the health care spend?

And Nigel, I always talk about it this way, portfolio is a continuous process for us. It really is part of our growth strategy. It complements what we do in innovation. It's important for us in multiple dimensions. The first is helping us prioritize where we invest organically, looking at where we can have the best advantage from our differentiated capabilities, most attractive markets. It's about identifying acquisitions that can put us into new market areas, leverage the strengths of 3M and a greater than the sum of parts kind of integration. And then it's about really maximizing value for shareholders. This portfolio is ensuring that our innovation delivers on that focus that I just talked about and also delivers value for -- the most value for shareholders. And so we'll take actions as we've talked about. We -- sometimes it means operating our businesses differently. Often that has meant divesting, spinning out parts of the company where there was an owner that could create more value and it was a greater value for our shareholders. And so health care is certainly the biggest example of that. We -- just prior to -- well, just a little over a year ago, we completed the separation of food safety, which was a material science-based business in 3M generating good growth and margins. But we recognize we could create more value with that by separating it and combining it with NEOGEN, and it's been a very successful combination for that business. And so we'll continue to evaluate, actively manage our portfolio to ensure that we're driving our organic investments in the right place, but importantly, also operating our portfolio and managing our portfolio up to and including divestitures to really deliver value for our shareholders.

Great. Thanks, Mike. You mentioned acquisitions there. And obviously, we haven't seen too many acquisitions in the last several years. Does the visibility of getting these two settlements signed off in court approval, does that give you more confidence to deploy capital into acquisitions?

Well, Nigel, our company has a strong balance sheet, as you know. And it's -- for 3M going forward, as we spin out health care, that balance sheet will get even stronger. So I -- we are positioned to continue to execute our capital allocation priorities. The first is continue to invest organically, R&D, CapEx. It's also about prioritizing a dividend as returning value to shareholders. And then M&A is an important way to create value. So we continue to execute on those priorities. We -- M&A in the last year, in particular, we've been very focused and have a tremendous amount of resource going into successfully spinning off health care. So that is the priority #1 right now. But going forward, we will continue to look at M&A as an important way to create value and leverage -- also leverage our capabilities, our differentiated capabilities.

Okay. Great. The R&D pipeline, investing in R&D, obviously, that's the biggest priority in investing products. Is 6% R&D still -- R&D as a portion of sales, is that still the right level R&D for 3M going forward? Could it increase? Is there room for optimization of that...

Yes. I would say, first of all, when we look at our allocation of capital into R&D, we're looking at it across our businesses and our products. And we look at where do we believe we can drive the greatest performance, where can we drive investments either in adding capabilities for customers that are existing or driving new opportunities or even new entire businesses. So we're always looking at where we see the strongest return on our investments -- organic investments, R&D, in particular. And so we've been investing in R&D at between 5% and 6% of sales. It reflects all of the things that we're doing to drive that model that I talked about across the business. It's not uniform. So you would -- when you look at R&D as a percent of sales across the company, it's not uniform. In our consumer business, for example, it leverages the invention of the broader company into retail channels. And so that's an area where we can take advantage of a multiplier there. Health care has, historically, been a higher-than-average investment area for us as we saw the opportunities for growth and innovation. So we'll continue to look at it that way. We're going to look at how each business can take advantage of investment in R&D. In the end, it's going to be an outcome of how we look at our portfolio and how we look at corporate priorities more broadly. So it's -- we continue to see the opportunity to, as I talked about earlier, drive that growth in value and refresh our portfolio, but we're going to do that based on a portfolio view of the company.

Then my final question is really around -- coming back to the margin question, it seems like you've got a lot of margin momentum going into next year. And is there any reason why 3M RemainCo's margins can't exceed where they've been in the past? I mean obviously, the hallmark of 3M has been very high quality, very high-margin companies. But is there any reason why we can't get to a 50% gross margin for 3M RemainCo?

It's an important focus as we've been talking about here today, Nigel. We are driving a number of areas of focus in that execution in our supply chains end-to-end in particular, driving productivity as we talked about, driving improvements in yield, really driving end efficiency of our supply chain, all of that can contribute to strong gross margins. So we have been making progress as we come through this year. We're building momentum. We have the restructuring actions that are part of that, as I've called out, the restructuring actions that are part of our gross margin kind of cost structure. And then we -- the biggest way for us and the most important and impactful way is growth, leveraging growth as we move forward. Bruce talked about it, we'll continue to leverage that opportunity to invest in additional areas for growth and value creation, but that will be part of it. So we are certainly focused on continuing that momentum as we go into 2024. Again, we'll come back with a more complete view of how we're looking at the year as we get into our Q4 earnings call.

Great. Well, Mike, that's all my questions. So I'll hand it back to you for any closing remarks you have.

No, Nigel, I would just say thanks for the opportunity to spend some time with you today. This is -- I would say we feel good about the progress we've made in 2023. We're building momentum. Those priorities that I talked about, they continue to be our focus. We're going to stay focused on that as we work to close out a strong 2023. We'll be back to talk about '24 in January.

Right. Well, Mike, the pleasure is all mine. Happy holidays. Good luck with the close-out the year, and I guess, we'll catch up in January.

Thanks, Nigel.

Thanks, Mike. Thanks, Bruce.

Thanks, Nigel.