3M Company (MMM) Earnings Call Transcript & Summary

So Bill, it's been now, what almost 2 years since you've been in the job, notwithstanding a market and a macro that has been somewhat unforgiving.

I guess what would you say have been some of your biggest successes in real learnings over the last 12 months or so?

Well, thanks for having me. It's great to be back. Congratulations on your new role. So again, it's about 2.5 years at 3M making -- the team is making, I think, great progress building fundamentals, improving how we execute the consistency in how we execute. So the first 2.5 years were really around just a back-to-basics focus on fundamentals approach. -- across operations and all of our supply chain, across innovation, across commercial, doing commercial excellence. I think importantly, also building a culture of accountability and rigor and speed and urgency, things, I think, go hand-in-hand with good day-to-day execution. And I think when you look at the progress that's been made over the last 2.5 years or so, we are clearly making progress. We're seeing more sustained organic growth. We're seeing clear step-up in margins. We're seeing an acceleration of new products in the marketplace, more hustle at the front end of our sales force and we're tracking ahead of our 2027 Investor Day targets, which we said at the beginning of last year, when we had our first Investor Day. So I think all of those pieces, I think, are going -- are going very well. I feel very proud for what the team has accomplished, particularly on the culture side, which I think is an important dimension. So I mean, those are things I think have gone pretty well. In terms of learnings, lessons. Look, I think 1 focus matters, clearly, clarity and transparency externally and with the team inside of the company is critically important -- and also, as you all know, execution in cultural change happens hand in hand. You can't have 1 without the other. You can't see sustainable performance improvements in execution. If you're not adjusting culture. So again, really good progress on the fundamentals. 2 years in gives us confidence in the trajectory that we're on to now shift more towards how do we transform the organization, take a harder look at our processes, structural cost and all those things, which would give us a runway beyond 2027 in terms of margin expansion and organic growth. So I mean, I think it's been a good 2.5, 2.5 years, it goes very fast, as you imagine. But good progress, and I think we're all set up for the next 2.5 years.

Great. Maybe let's double click a little bit more on the execution and operational excellence. You've successfully moved on time in full delivery above 90% threshold from the low 80s. What do you think is the next frontier for operational productivity as you look forward? .

So look, OTIF is run or on time in full is 1 metric. And you're right, we were in which case, it's -- you're really not anywhere near what you're performing to what customers expect. We're now consistently running around 90% parts of the company, the consumer running more consistently mid-90s we're still not where we need to be. I'm pleased with the progress, but not where we need to be. We're seeing -- I mean today, from 2.5 years ago, on time and full is not really a conversation with distributors. It's not necessarily a pain point. We do have opportunities. I think we're holding our own serve here, but it is an opportunity to distinguish ourselves here. But operational excellence goes way beyond just long time in full. That's 1 metric. It's a very important one. It's all these others that I've been talking about with investors since I started around gross and net productivity around utilization or operating equipment effectiveness around cost for quality, all of those dimensions go into building a very strong foundation and execution model, that's what really we're focused on, but OTIF is a key part of it. So again, what's coming next, we see that marching higher, but it's not just on improving on time in full, but the key is to do that with lower inventory and actually compressing your cycle time at the same time. And if you could do that, it's like a triple double. If you drill those 3 together, that's what we're trying to do. Right now, we're focused on OTIF, we're going to bring inventory down and start to neck in some of the lead time to our end of end customers. I think that's what we distinguish the company going forward.

Right. I guess, let's just take this on a level. So how does this higher service level really translate directly into lower customer attrition or higher market share on the ground? .

Look, it's 1 dimension. I mean, at the end of the day, when we think about -- our attrition has been running relatively hot. It went up when our service levels went down. starting to come down as our service levels are coming up. It's hard to go point to point, what's a point of OTIF to a point on attrition. But at the end of the day, as I said, it's -- it was a pain point. It's not so much a pain point today. it is a key factor. We are doing -- we've done some work using AI tools to develop both predictive and responsive mechanisms, agents to understand when churn might be happening instead of letting it happen, but doing something proactively about it, having a closed-loop system. So as you're starting to see indications of customers wanting or desiring to shift their business, our salespeople go and do something, the managers can follow up. So it is -- it's a factor. It's not the only factor, quality performance, other things actually go into that price becomes a dimension, but OTP is clearly 1 that drives attrition.

Great. Maybe let's shift forward to the portfolio and the priority verticals you guys have outlined and your R&D pivot. You've aligned 80% of your R&D spending with what you call priority verticals like semiconductors and data centers. How are you measuring the accountability of this R&D spend? .

So this -- 1 of the key growth drivers of the company is getting us back to innovation. I call it innovation excellence, and it's really pivoting the company towards a more what I call internally the factory we call R&D mechanized with clear KPIs, focus on developing, launching new products. I think you can see that we're making some progress here. So on-time assessment wasn't measured. We're now running consistently 80% we're running a more centralized governance of R&D, which allows us to drive more of our spend to these priority verticals or places where we have a right to win, where technology differentiates now 80% of our investment across the company is going after these -- into these priority verticals, which I think is an important focus. The funnel health is good. We're seeing clearly an acceleration in the launch of new products. 3 years ago, we launched about 125 products in a given year. It's way down from what was historical where we move in to 700, 800 per year range. Last year, we launched 284. This year, we'll launch more than 350. So it's about triple where we were 3 years ago. And you could see the effects of that. We're starting to see new product sales, 5-year new product sales start to increase our new product vitality index, which we measure on a 5-year sales basis is coming back up. It was 11%, now it's mid-teens, at the end to hit 20% or so by the end of next year and continue to rise. Historically, 3M for an innovation-driven material science company we've historically been around 25%. So why is that important? Vitality Index is an indication of the freshness of your portfolio. So if you're a salesperson and you're going to see going in to see a customer and you're not delivering on time in full, you're trying to drive price because material costs are going up and you have nothing new to say because you're not innovating, it's a very tough job. In fact, we're changing that dimension. We are starting to see drop to the bottom line now revenue coming from new product innovation. This is a key focus. It's a longer-term journey. I said it's going to be shifting over time from more upfront. We'll see more benefits from commercial excellence of selling more of what we have. And it's going to pivot over time towards growth coming from new product innovation, and you can clearly see that in our numbers. This year, we'll do more or less $400 million above the macro. Half of that or more than half is coming from innovation. And as we go into 2027, more will come from innovation. And why is it happening? Because we're shifting from incremental projects, Class III projects that we call more to 4s and 5s, which are driving us more into adjacencies or new businesses. And that's where you really get to the true net growth. So that's all we're trying to do is to mechanize this factory, we're calling R&D. And in fact, we're seeing good performance. We're measuring very carefully business cases, but holding people accountable to the output, the outcomes? Are you getting the growth? Are you getting the margins that come from the investments that investors were all putting into R&D inside the company.

Great. I guess following on that, right, these new businesses and these new growth vectors you guys are isolating. Let's touch on data centers can't have a conference these days without talking about data centers, it feels like. And so your partnership with Microsoft for expanded Beam optics, it's a major milestone. And the TAM is projected to reach $2 billion by 28. What is your strategy for licensing this technology to ensure it becomes the industry standard while maintaining your competitive edge? .

So EVO, we started talking about this with investors earlier this year. It's expanded Beam Optics. It's a technology that 3M created with lots of patents around it that allows a a durable dust resistant, very easy to install fiber to fiber connection inside the data centers. intumeproven to reduce installation cost by 85%. And when you're building data centers today, there's hundreds of millions of fibers, individual fiber strands that historically have been put together point to point as opposed to an expanded beam technology, which we have. And again, it's thus resistant. These environments are very dusty. It takes a lot of labor and time to mold and connect to individual fiber strands and this technology is pretty resilient. So Microsoft had been in testing for several years and has proven out the case, we announced earlier this year, a couple of months ago that we signed a strategic partnership with Microsoft part of it is around EBO and that's a key part of it. They're standardizing on EBO interior data centers. That will expand from there. There's qualification, proofs-of-concept happening today with 5 other global hyperscalers, that will come out over time. But as you watch what's happening in data centers, it's -- there's a clear shift from copper interconnect, which we also participate in, the optical interconnects, you're going to see that move dramatically over time. So the opportunity for us is quite large, and it's taking hold. Microsoft is the first one, but there's certainly others. The key to success is not doing this as a stand-alone company. It's about how you enable the ecosystem. There's no hyperscaler that's going to buy anything individually from any single company that's just not going to end up happening. So what we're doing is we're putting a lot of time into enabling this ecosystem. We formed an MSA, there's 44 companies in it, the hyperscalers, chip designers, connected companies, other contract manufacturers are in there, is really how do you standardize this technology, develop common specifications. And part of that is licensing other folks to actually do the technology, to do EBO, which I think is an important element for how you grow this overall ecosystem. We're scaling it internally. We're going to double our capacity this year for EBO production inside of 3M. But there's just no way that 3 of them alone can actually satisfy the market demand and the speed at which it's coming at us to deliver against. So it's requiring us to think very differently about contract manufacturing and people that have been in the market that could scale very, very quickly. We have signed a CM agreement, a contract manufacturing agreement, both technology as well as manufacturing. It will scale over time. Every hyperscaler is a little bit different. They're Vector designs are slightly different. Some are 12, some '16, some are other numbers of fibers per Farrell. And it's going to change over time, but each 1 takes a little bit of engineering work to go in deal and perfect that. But it's going to scale. This year, it's nominal. It's approaching a $2 billion TAM in a year or 2 -- it's -- but it's proving itself out, and it really starts with enabling this ecosystem. And for us, it's not just selling a Ferodo a data center. It's what other opportunities does it open for us. There's other things we can do along the fiber path. Part of it right now, it's a polymer EVO, it's for certain applications inside of a data center. But as you know, as you go closer to the chip and bring optics to a chip, it requires a different heat resistance and probably a different technology, more ceramic than polymer. And that's actually quite a deep expertise of 3M as well. So that's the path we're going down. We do have optical and copper connections inside the data center tons of opportunities around that. So if you read the Microsoft agreement is a strategic partnership agreement, it's we're a material science partner, what that's allowing us to do there and with other hyperscalers have a different dialogue. -- on how we can bring material science, technology and expertise of the company to bear to help with these hyperscalers and think way beyond just connecting 2 Bs of fiber. So it's pretty exciting. It's -- we'll keep updating investors on progress here, but we're off to a good start. We have 100 patents in the space, 50 patents, 50 pending. So we've got good IP protection. But again, the success here is about how do you enable the ecosystem.

Makes sense. I guess, let's just double click on that. What other projects or products are you developing for the data center market today? And when could we expect to see some of these come to market perhaps? .

Data center business today, last year it was around $600 million is growing, of course, both inside and outside the data center. So the optical -- in the copper interconnects inside the data center are a part of it. That's a smaller part outside. We do a lot of terminations and splices to bring meeting voltage cable to the data center. -- an interesting technology, it's 1 we've been in the market with for a long, long time. It's around a ceramic technology, Nextel fiber. Nextel Hibor is very durable. It's heat resistance. It's got structural integrity -- and it could be useful, it is useful in some behind the meter applications like fuel cells. And there are some really interesting developments happening there. Again, it's having us to step back and think about how do we scale to the demand. We've been producing Nextel for a while, goes in a variety of different applications. But the demand that's coming at us right now outstrips our capacity. So we're having to invest, we're having to think differently about how we run that part of the business. So this is a -- it's a very interesting opportunity for us. We're not a big player in data centers. So even if things start to move around a little bit, there's -- so maybe some pullback in data center construction. I think we still have a huge opportunity to gain share in that very, very large pool of capital going into that business.

Great. Maybe outside of the growth initiatives and the R&D, let's talk more about the portfolio as you see it today and how are you identifying some of the drag businesses within your 120 different profit centers. .

So at the Investor Day, we laid out our approach here and hasn't really fundamentally changed. Look, we -- there are businesses that I think are very attractive within 3M, where we have where they're growing well, where there's high margin potential from where we sit today, where we have a right to win with technology is critical to differentiation. Those are the kinds of businesses that we want to be in. That's what 3M is all about. We're not a commodity company. We're a material science organization. And and we're investing in them. And I think I mentioned a minute ago, it both organically, so we're shifting our R&D dollars to those priority verticals in a really significant way, which I think is important as we get more bang for the buck on R&D. We're also investing inorganically in there. That was the Madison Fire & Rescue business we acquired in concert with a private equity partner of ours. We contribute our SkySCBA business. So very premier fire safety system businesses in a very sticky marketplace with a large TAM, we're growing high single digits, margins above the company average on EBITDA going in. And on top of that, there's opportunities through complementary cross-selling across the business. It's an area where there could be bolt-on acquisitions over time, working in concert with the private equity firm, great opportunity to continue to drive margin expansion. So there's clear opportunities for us to continue to pivot the portfolio to these areas, which I think are attractive and growing. And again, where technology differentiates. Of course, on the other side of the spectrum is so businesses that are more commodity like, where we don't really see the ability to invest in technology to differentiate the market, the differentiate our offering in the marketplace. -- this year, we closed on the precision grinding and finishing business, not very big, but it dragged along 7 factories. It was a business that wasn't performing very well. more commodity-like and we got out of that business. But there'll be more over time. There's not a specific time frame for doing this, but the -- but we'll look hard at what things should we be pulling out of. At the same time, we're looking at what things should we be moving more into inorganically show you shift and pivot the portfolio. And that's that's an ongoing portfolio management conversation.

Great. Maybe before we pivot over to near-term operating dynamics, I'll just take a pause to see if there's any questions from the audience -- going once. -- going twice. It was a late night for everybody, I guess. All right. Well, let's take a look at at the current operating environment. So most recently, you guys just delivered a very solid organic growth quarter with 5.5% or 5.4% organic growth in the second quarter. which was roughly 2x the underlying macro and momentum. So how much of this outgrowth do we think is sustainable and real structural change versus just perhaps a temporary boost from channel inventory harmonics or onetime commercial excellence gains. .