3M Company (NYSE:MMM) Q3 2023 Earnings Call Transcript

3M Company (NYSE:MMM) Q3 2023 Earnings Call Transcript October 24, 2023

3M Company beats earnings expectations. Reported EPS is $2.68, expectations were $2.34.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the 3M Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, October 24, 2023. I would now like to turn the call over to Bruce Jermeland, Senior Vice President of Investor Relations at 3M.

Bruce Jermeland: Thank you and good morning, everyone and welcome to our second quarter earnings conference call. With me today are Mike Roman, 3M’s Chairman and Chief Executive Officer; and Monish Patolawala, our President and Chief Financia. Mike and Monish will make some formal comments, and then we will take your questions. Please note that today’s earnings release and slide presentation acCompanying this call are posted on the homepage of our Investor Relations website @3m.com. Please turn to Slide two. Please take a moment to read the forward-looking statement. During today’s conference call, we’ll be making certain predictive statements that reflect our current views about 3M’s future performance and financial results.

These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-Q lists some of the most important risk factors that could cause actual results to differ from our predictions. Please note, throughout today’s presentation, we’ll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments to today’s press release. With that, please turn to Slide three and I’ll now hand the call off to Mike. Mike?

Michael Roman: Thank you, Bruce. Good morning, everyone, and thank you for joining us. In the third quarter, we built momentum through strong operational execution as we again delivered for our customers, positioning us for a solid close to 2023. On an adjusted basis, we delivered earnings ahead of our expectations, expanded margins sequentially across all four businesses, and achieved our third consecutive quarter of double-digit year-on-year growth in free cash flow. As we make progress and deliver improved financial results, we are increasing our full-year adjusted earnings per share guidance to $8.95 to $9.15, up from a previous range of $8.60 to $9.10, and our adjusted free cash flow conversion range to 100% to 110%, up from 90% to 100% previously.

We continue to deliver against our priorities. We are driving performance throughout 3M with strong operational execution, restructuring actions, and spending discipline. We are progressing the spin of the healthcare business, which we expect to be completed during the first half of 2024. And we are reducing risk and uncertainty by reaching significant settlements to address combat arms and PFAS litigation. I will now provide some additional context around how we are advancing these priorities. Next slide, please. Our margin expansion clearly demonstrates the performance our team is driving throughout 3M. We delivered 240 basis points of year-over-year adjusted operating income margin expansion, excluding 80 basis points of restructuring-related charges.

We are strengthening our business in several important ways. We are progressing with our restructuring actions to streamline our organization, reduce structural costs, and get us closer to customers. We have leaned out the center of our Company, simplified our global supply chain organization, and optimized our global go-to-market models. At the same time, we are advancing supply chain performance to improve service, drive productivity and yield, expand gross margins, and increase cash conversion. These results are being supported by initiatives that use our continuous improvement toolkit and leverage data and data analytics. For example, we have benefited from more than 60 Kaizen events this year to improve existing processes in our largest plants.

We are also progressing the spin of our healthcare business, building the leadership team as we work toward completing the spin in the first half of 2024. During the quarter, we added two experienced leaders, naming Bryan Hanson as the CEO of the Standalone Healthcare Business and Kerry Cox as the Board Chair. Finally, we continue to manage risk and uncertainty by proactively and effectively managing litigation. We announced the combat arms settlement, and we are working with all parties and the courts to implement it. The settlement administration process has been established and funded. The bellwether trial verdicts have been settled, and the process for notifying and settling with claimants has begun. With respect to PFAS, the public water supplier settlement we announced last quarter has received preliminary court approval.

We successfully resolved objections from state attorneys general and are working toward approval with the final hearing set for early February next year. In closing, I want to share a few thoughts about our future. Our momentum accelerates our ability to define where we go next at 3M. As we prioritize attractive markets, where we have the right to win, and the opportunity to differentiate ourselves through our unique capabilities and strengths; a good example is our automotive OEM business, where we continue to outperform the market with double-digit growth this quarter. Auto electrification is on track to be a $600 million business this year and has delivered organic growth of 30% year to date. Our material science expertise has led us to build a new business, and we see similar opportunities in other core platforms such as safety, home improvement, and consumer electronics.

We are also prioritizing emerging global trends that have attractive growth rates and customer needs that match up well with 3M capabilities. We are building new platforms in areas like climate technology, industrial automation, and next-generation electronics. Before I hand it over to Monish for additional insight into our performance, a few closing thoughts. I am pleased with the way our teams are executing. They delivered third-quarter results that build on the momentum we saw in the second quarter, setting us up for a solid close to 2023. We are advancing our priorities, driving performance, progressing our healthcare spin, and reducing risk and uncertainty. 3M is delivering today lower costs, better margins, and greater cash generation and building for tomorrow, prioritizing growth platforms, innovating with impact, and empowering our teams.

I will now turn it over to Monish for more details on the third quarter and our outlook for the rest of the year. Monish?

Monish Patolawala: Thank you, Mike, and I wish you all a very good morning. Please turn to slide five. As Mike mentioned, we are seeing significant traction from the actions we are taking to strengthen the business. Through a focus on customers, effective adjustment of production, benefits from efficiency and productivity initiatives, ongoing proactive spending discipline, and the relentless focus on managing inventory, we were able to deliver solid adjusted third-quarter results, including sales of $8 billion at the high-end of our guidance range of $7.9 billion to $8 billion, operating margins of 23.2%, an increase of 160 basis points year-on-year and 390 basis points sequentially; earnings per share of $2.68, a year-on-year increase of 3%, and free cash flow of $1.9 billion, up 39% year-on-year with conversion of 130%.

Organic sales on an adjusted basis declined 3.1% versus last year. This included an expected year-on-year headwind of approximately $140 million, or 1.7 percentage points related to lower disposable respirator demand and last year’s exit of our operations in Russia. Excluding this, Q3 adjusted organic sales were down 1.4%. Consumer and electronics end markets continue to be soft. Our adjusted organic sales declined year-on-year mid-single digits in our electronics business and high-single digits in consumer. This softness was partially offset by strength in our automotive OEM business. Regionally, the U.S. was up slightly despite continued challenges in retail. Europe remained soft, and China was down mid-teens year-on-year organically due to continued end-market softness along with lapping strong sales backlog recovery in the prior year.

Our strong adjusted EPS of $2.68, exceeded our expectations of $2.25 to $2.40. Roughly two-thirds of the beat was driven by operational execution in our supply chain and proactive spending discipline, and a balance driven by restructuring timing. The restructuring actions we announced earlier this year are largely on track and we are seeing favorable margin impact in our results. We continue to expect full year pre-tax restructuring benefits of $400 million to $450 million with offsetting charges. Turning to slide six for the components that drove our year-on-year operating margin and earnings performance, manufacturing productivity and restructuring actions, strong spending discipline, and selling prices partially offset by lower sales volume, investments in the business, and the previously mentioned headwind from disposable respirator and last year’s exit of Russia, resulted an improvement to operating margins of 260 basis points and to earnings of $0.22 per share.

Pre-tax restructuring and related charges in the quarter were $68 million or a negative impact to margins of 80 basis points and $0.10 to earnings. This charge was lower than our anticipated range of $125 million to $175 million in Q3 due to factors that impacted the timing of actions that are being pushed into Q4. The carryover impact of higher raw material logistics and energy cost inflation created a year-on-year headwind of approximately $25 million, or a negative 30 basis points impact to operating margins and $0.03 to earnings. Foreign currency translation was a positive 0.6% impact to total adjusted sales. This resulted in a $0.01 tailwind to earnings per share. Last year’s food safety divestiture and the reconsolidation of aero technologies resulted in a net year-on-year tailwind of 10 basis points to margins and no impact to earnings.

Finally, other financial items decreased earnings by a net $0.02 per share year-on-year. In summary, our team’s focus on driving productivity, executing restructuring actions, and controlling spending continues to yield results. These actions drove meaningful year-on-year and sequential improvement in adjusted operating margins. Please turn to slide seven. Third quarter adjusted free cash flow was $1.9 billion, up 39% year-on-year, with a conversion of 130%, up 360 basis points, versus last year’s Q3. This year-on-year improvement was driven by an ongoing focus on working capital management, especially inventory. Inventory was down over $200 million sequentially and $550 million year-on-year as we benefit from the power of daily management and data and data analytics to speed up inventory terms.

As always, there is more we can do and will do to continue to realize benefits from our actions as we move forward. Adjusted capital expenditures were $367 million in the quarter as we continue to invest in growth, productivity, and sustainability. During the quarter, we returned $828 million to shareholders via dividends. Net debt at the end of Q3 stood at $10.8 billion, a reduction of 11% year-on-year. Our business segments continue their long history of robust cash flow generation. In addition, our proven access to capital markets, along with the anticipated one-time dividend from the spin of health care at leverage of three to three and a half times EBITDA and 19.9% retained stake will provide additional financial flexibility. This, combined with our existing strong capital structure, provides us with the ability to continue to invest in the business, return capital to shareholders, and meet the cash flow needs related to ongoing legal matters.

Now, please turn to slide nine for our business group performance. Starting with our safety and industrial business, which posted sales of $2.8 billion or down 5.8% organically, this result included a year-on-year headwind of approximately $130 million, or 4.3 percentage points, due to last year’s COVID-related disposable respirator decline and exit of our operations in Russia. Excluding this, Q3 adjusted organic sales were down 1.5%. Personal safety was down high single digits due to last year’s COVID-related disposable respirator comp. Excluding disposable respirators, personal safety was up high single digits organically. Closure and masking continued to be impacted by lower packaging and shipping activity, and industrial adhesive and tapes by end-market softness in electronics.

Abrasives, electrical markets, and automotive aftermarket declined versus last year’s strong comparisons. And finally, organic growth in our roofing granules business was up high single digits. Adjusted operating income was $708 million or up 5% versus last year. Adjusted operating margins were 25.7%, up 250 basis points year-on-year and up 350 basis points sequentially. The year-on-year improvement in margins was mainly driven by ongoing productivity actions, restructuring benefits, strong spending discipline and price. Partially offsetting these benefits were headwinds from lower sales volume and restructuring costs. Moving to Transportation and Electronics on Slide 10, which posted Q3 adjusted sales of $1.9 billion. Adjusted organic growth declined 1.8% year-on-year, largely due to expected weakness in electronics.

Our electronics business experienced a year-on-year mid-single-digit decline in adjusted organic sales as semiconductor and data center end market demand continues to remain soft. We are starting to see signs of stabilization in consumer electronics end market. However, we are closely monitoring demand trends as we head into the upcoming holiday season. Our auto OEM business had a strong quarter, increasing approximately 16% year-on-year versus a low single-digit global car and light truck build, as we continue to gain penetration on automotive platforms. Turning to the rest of Transportation and Electronics, commercial solutions and transportation safety both declined mid-single digits year-on-year, mainly driven by weakness in China, while Advanced Materials grew low single digits.

Transportation and Electronics delivered $494 million in adjusted operating income, up 21% year-on-year. Adjusted operating margins were 26.3%, up 460 basis points year-on-year and up 650 basis points sequentially. The year-on-year improvement in margins was driven by productivity actions, restructuring benefits, strong spending discipline and price. Partially offsetting these benefits were headwinds from lower sales volumes and restructuring costs. Looking at our health care business on Slide 11, Q3 sales were $2.1 billion, with organic growth up 2.4% versus last year. Organic sales in oral care were up high single digits year-on-year and medical solutions grew low single digits organically, including continued impact from lower post-COVID-related bio-pharma demand.

Health Information Systems declined low single digits due to tighter hospital budgets. As procedure volumes continue to improve and hospital budgets stabilize, we are confident in the long-term outlook of this business. Health Care’s third quarter operating income was $460 million or up 2% year-on-year. Operating margins were 22.2%, up 50 basis points year-on-year and up sequentially 240 basis points. The year-on-year improvement in margins was driven by productivity actions, restructuring benefits strong spending discipline and price. These benefits were partially offset by restructuring costs. Finally, on Slide 12, our Consumer business posted third quarter sales of $1.3 billion. Organic sales declined 7.2% year-on-year as discretionary spending trends on hard-line categories remains subdued.

The back-to-school season was soft and rising interest rates continue to impact the housing market and related spending. Consumers’ third quarter operating income was $269 million, down 10% compared to last year with operating margins of 20.5%, down 70 basis points year-on-year, however, were up 230 basis points sequentially. The year-on-year decline in margins was driven by headwinds from lower sales volumes and restructuring costs. These headwinds were partially offset by benefits from productivity actions, restructuring and strong spending discipline and price. That concludes our remarks on the third quarter. Please turn to Slide 14 for an update on our full year’s expectations. Our strong third quarter performance shows the results of the significant actions we have put in place this year to generate better productivity yield and efficiency from our supply chain, drive simplification, manage costs and deliver for our customers in an uncertain macro environment.

As a result, we are raising our full year 2023 adjusted earnings per share and free cash flow conversion guidance. We now expect full year adjusted earnings in the range of $8.95 to $9.15 versus our prior range of $8.60 to $9.10. We are also updating our full year adjusted free cash flow conversion to be in a forecasted range of 100% to 110% versus 90% to 100% previously. Based on our year-to-date performance, we expect full year adjusted organic growth to be down approximately 3% versus our prior guidance to be at the lower end of flat to minus 3%. This updated expectation includes an incremental headwind of $50 million from continued softness in disposable respirator demand. We now estimate a full year sales decline for disposable respirators of approximately $600 million versus $550 million previously.

Looking ahead to the implied fourth quarter, we expect end market trends to be consistent with Q3. Hence, we anticipate fourth quarter adjusted sales to be in the range of $7.6 billion to $7.7 billion, taking into consideration normal seasonality with fewer sales days due to holidays. Fourth quarter pre-tax restructuring charges are expected to be in the range of $70 million to $120 million, incorporating the timing impact I mentioned earlier, with pre-tax benefits of $145 million to $195 million. Taken together, we expect fourth quarter adjusted earnings per share will be in the range of $2.13 to $2.33. To wrap up, we are very focused on our priorities by driving improved performance through strong operational execution, progressing on our restructuring actions and spending discipline successfully spinning off health care and reducing risk by managing litigation exposures.

At the same time, we are positioning 3M for the future as we prioritize the most attractive markets, invest to support continued innovation and capitalize on emerging opportunities. We expect our actions will continue to build momentum and drive long-term improvement in our organic growth margins and cash flow performance into the future. As we exit 2023, we will be a stronger, leaner and a more focused 3M, and I remain confident in our future. Our solid third quarter is a direct result of the hard work of 3M employees. I want to thank them for their dedication and focus as they continue to deliver in partnership with our suppliers for customers and shareholders. That concludes my remarks. We will now take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Scott Davis with Melius Research. You may proceed with your question.

Scott Davis: Good morning, Mike, Monish, and Bruce. I haven’t been able to say this in a while, but a pretty solid, complete quarter overall, so some progress there. But, guys, I want to back up a little bit. What are the remaining steps to get health care spin complete? Any big hurdles still remaining?

Michael Roman: Yes, Scott, I would say the team continues to make very good progress. And so we don’t see any hurdles ahead of us. There’s a lot of work to do to get ready for the spin and so we’ve got work to do, getting ready for each step of that process. As we talked about in my remarks, we named the CEO, and we’re adding to the leadership team and getting that built out. So that’s really an important foundation. We have the Board Chair named and continue to work on filling out the Board. So those are important steps. I don’t see — the team has given us great confidence that we’re going to continue to progress. And we’re on track for the timing that we talked about in early 2024 and see ourselves getting there successfully.

Importantly, for us, it’s — much of it is and we’ve talked about, it’s about getting ready for the spin of health care, it’s also about getting ready to stand up 3M as a stand-alone Company with a health care spin being completed. So we’re putting focus there. And even what we talked about in the quarter that really driving the priorities that we are talking about, the execution in our operational execution is an important part of getting ready for 3M for the spin as well, and we’re making good progress there, as you noted.

Monish Patolawala: Just process-wise to add to Mike’s comments, the teams are working through system changes, standing up legal entities and as well as all the regulatory filings, Scott, that we need to do, and that’s what everyone is focused on from the health care side.

Scott Davis: That’s helpful. So Mike, just taking your comments a little further, at the new 3M, do you envision a new 3M or you can kind of run at lower levels of CapEx, lower levels of even potentially R&D as a percent of sales. And the knock on 3M was always that it costs a lot of money to drive a point of growth and sometimes with the incrementals that worked out well. But in down cycles, that certainly did not work out well. But is there a new vision in 3M, I should say, that you can run at kind of more productive, efficient levels of CapEx and R&D?

Michael Roman: Yes. Scott, there’s a couple of dimensions to the answer to your question. The first starts with what we’ve been talking about. We announced a restructuring back in Q1, and that was really coming from what we had learned as we operated our businesses and we looked at where we were going with our supply chains in the face of some of the challenges in supply chains globally. And it was really behind that was an expectation that we could drive greater productivity, improvement in our execution, stronger performance, improved margins. And so that was really the foundation of that restructuring. And so I think part of the answer to your question is we took those decisions to lean out the center of the Company, simplify our supply chain, streamline our go-to-market models.

Those are a foundation for the future of 3M. And those are — you can see starting to demonstrate that we can drive improved financial performance for the Company. And that’s — we expect that to be a foundation for the future as well. I even talked about this is with that performance starting to build some momentum, we can accelerate how we view the future. And then you are talking about investing in growth and innovation and productivity and sustainability. And we’ll continue to be our capital allocation, first priority is going to be investing in organic growth in R&D and CapEx. And really, thinking of and targeting high-growth market spaces, places where we can differentiate ourselves with our innovation capabilities where we can be aligned to emerging market trends.

So I think that how we prioritize that investment is going to be aligned with where we see that ability to make a difference. So both are important foundations for the future.

Operator: Our next question comes from Andrew Obin with Bank of America. You may proceed with your question.

Andrew Obin: Yes. Good morning. Just a question on electronics. It’s been a headwind for a while. What KPIs are you looking at? When do you think — and I think you said that was broadly in line with expectations. But when do you see the light at the end of the tunnel? When does it bottom — what does it take for this business to bottom?

Michael Roman: Yes, Andrew, I would say we came through third quarter. We still saw as we said soft end markets for electronics, and that’s consumer electronics, it’s into semiconductor. It’s into a big part of our — what we have as a focus in our customers and electronics. When we look ahead, there’s some uncertainty, we’re starting to see, as Monish said, electronics stabilize. I think that really reflects that we don’t see it continuing to go down. It’s starting to stabilize. There’s some — companies are talking about things getting better as they go forward. I would say we’re watching it closely. We expect Q4 to look a lot like Q3 in our end markets, and I would say electronics included. So we’re watching what we always watch.

Our customers are large electronics customers in consumer electronics and semiconductor associated with data centers and those are the — that’s where we’re going to be taking the lead from where we see demand going, where we see market performance going, when we see the market improve. We’ll take the lead from them.

Monish Patolawala: Just another data point for you, Andrew, at the end of second quarter, we had said that the way we predicted electronics was the amount of negative Vs quarter-on-quarter would get better. So if you compare us to the first half and the amount we were down year-on-year versus the third quarter, we are less down. It doesn’t mean we are not down, but that’s another point that Mike was trying to make is that’s where we are starting to see some signs of stabilization. But as I said in my prepared remarks, I think we’ll have to just watch how the holiday season plays out.