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Edited Transcript of MMM earnings conference call or presentation 25-Jul-17 1:00pm GMT

ST. PAUL Aug 13, 2017 (Thomson StreetEvents) -- Edited Transcript of 3M Co earnings conference call or presentation Tuesday, July 25, 2017 at 1:00:00pm GMT

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* Inge G. Thulin

3M Company - Chairman, CEO & President

3M Company - CFO and SVP

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Citigroup Inc, Research Division - MD and U.S. Industrial Sector Head

BofA Merrill Lynch, Research Division - MD

JP Morgan Chase & Co, Research Division - MD

Deutsche Bank AG, Research Division - MD of Multi-Industry Sector of US and Senior Analyst

Goldman Sachs Group Inc., Research Division - VP and Lead Multi-Industry Analyst

* Julian C.H. Mitchell

Crédit Suisse AG, Research Division - Head of Global Capital Goods Research Team, Director, & Lead Analyst for US Electrical Equipment

* Robert P. McCarthy

Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the 3M Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Tuesday, July 25, 2017.

I would now like to turn the call over to Bruce Jermeland, Director of Investor Relations at 3M.

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Bruce Jermeland, [2]

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Thank you, and good morning, everyone. Welcome to our Second Quarter 2017 Business Review. On the call today are Inge Thulin, 3M's Chairman, President and CEO; and Nick Gangestad, our Chief Financial Officer. Each will make some formal comments, and then we'll take your questions.

Please note that today's earnings release and slide presentation accompanying this call are posted on our Investor Relations website at 3m.com under the heading, Quarterly Earnings.

Before we begin, let me remind you of the dates for our future investor events. Please turn to Slide 2. First, starting with earnings. Our Q3 earnings conference call will be held on October 24. The Q4 call will be next year on January 25. And lastly, our 2018 Outlook Meeting will take place on December 12. Please mark your calendars.

Please take a moment to read the forward-looking statement on Slide 3. During today's conference call, we'll make 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-K lists some of the most important risk factors that could cause actual results to differ from our predictions.

Please turn to Slide 4, and I'll hand the call off to Inge.

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Thank you, Bruce. Good morning, everyone, and thank you for joining us.

For 3M, the second quarter was marked by strong organic growth of 4% with positive growth across all 5 business groups. At the same time, we took a number of actions to better position our enterprise for success in both the short and long term. This includes accelerated strategic investments to support growth and strengthening our portfolio, along with M&A.

I will now take you through some of the numbers. As I mentioned, organic growth across the company was 4%, led by Electronics and Energy at 8%. Industrial and Safety and Graphics continue to grow well, posting organic growth of 4% and 3%, respectively. Health Care also grew 3%, and it was good to see our consumer business turn positive with 1% organic growth.

Company-wide, total sales were USD 7.8 billion, up 2% year-on-year. We delivered earnings of $2.58 per share, along with margins of 28%. Note that these results include impacts from both M&A and strategic investments, which Nick will cover in more detail. Excluding those impacts, core operating margins remained strong at more than 24%.

Turning to free cash flow. We posted a good conversion rate of 85% in the second quarter. Our healthy cash flow enabled us to invest in enterprise while also returning significant cash to our shareholders. And in the second quarter, we returned $1.2 billion to our shareholders through dividends and share repurchases.

That concludes my opening remarks. And I will now turn the call over to Nick, who will take us through more of the numbers. Nick?

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Thanks, Inge, and good morning, everyone. I'll start on Slide 5.

As Inge mentioned, GAAP earnings for the quarter were $2.58 per share. Since we had several moving parts this quarter, I thought I would take a moment to cover each item to make our underlying second quarter performance as clear as possible.

As Inge mentioned, we continue to execute our plans in Q2 to strengthen the company for the future. During the quarter, we made incremental strategic investments of $178 million. $39 million was growth related, and $139 million related to portfolio and footprint actions.

For the second half of the year, we anticipate another $0.20 to $0.25 per share impact from incremental strategic investments, largely footprint related. These actions drive greater productivity from our manufacturing and supply chain base and will improve our service to our customers.

Looking ahead, we expect footprint actions to be, at a minimum, an expense of $0.10 per share in 2018. This expectation includes benefits from actions implemented in 2017.

In addition, we had divestiture-related activity in the quarter, which added $0.57 to GAAP earnings per share, of which $0.54 relates to the Identity Management business. Taking into account these items, underlying earnings were $2.25 per share, up 8.2% year-on-year.

Please turn to Slide 6 for a recap of our quarterly sales performance. We posted good organic growth in the quarter of 3.5% with volumes up a solid 3.8%. Selling prices were down 30 basis points year-on-year due to a couple of factors. Strong volume growth in electronics had a negative impact on price, and we saw less price growth in Latin America as currencies were more stable versus the U.S. dollar.

We continued to actively manage the portfolio in Q2 and divested some nonstrategic businesses, which reduced sales by 100 basis points. Foreign currency translation decreased sales by another 60 basis points. All in, second quarter sales in U.S. dollars increased 1.9% versus last year.

In the U.S., organic growth was 1.9%, led by a mid-single-digit increase in Industrial. Our Health Care and Safety and Graphics businesses delivered low single-digit growth in the quarter. The Consumer business was down 1% organically in the U.S. in Q2, impacted by continued channel adjustments in the office market.

Asia Pacific led the company with organic growth of 10% in Q2. All business groups within APAC posted strong growth in the quarter, including a double-digit increase in Electronics and Energy and high single-digit growth in each of our other 4 business groups.

Organic growth was 17% in China/Hong Kong and 8% in Japan. Excluding our electronics-related businesses, China/Hong Kong grew 12% and Japan was up 4%.

Moving to EMEA. Organic growth declined 2% in Q2 with a similar result in West Europe. This area experienced fewer billing days versus last year due to the timing of the Easter holiday. Through the first half of the year, EMEA grew 1% organically, led by our Safety and Graphics and Industrial businesses.

Finally, Q2 organic growth in Latin America/Canada was 4% with all businesses posting positive growth. Health Care led the way, up high single digits, and Consumer grew mid-single digits. At a country level, Mexico continued to deliver strong organic growth at 8%. Brazil was up 6% while Canada grew 3%. We continued to generate broad-based growth across the globe, giving us confidence in our full year expectations, which Inge will discuss later.

Please turn to Slide 7 for the second quarter P&L highlights. Company-wide, second quarter sales were $7.8 billion with net income of $1.6 billion, up 23%. On a GAAP basis, second quarter operating margins were 28% or 24.3% year-over-year excluding the previously mentioned impact from incremental strategic investments and divestitures.

Let's take a closer look at the various components of our margin performance in the second quarter. Gains from organic volume growth and productivity contributed 60 basis points to operating margins. Lower raw material costs net of selling price changes added another 10 basis points. Foreign currency net of hedge gains brought margins down 50 basis points in the quarter, while higher year-on-year pension and OPEB expense decreased margins by 30 basis points. Finally, incremental strategic investments reduced margins by 2.3 percentage points, and divestiture-related activity benefited margins by 6 percentage points.

Let's now turn to Slide 8 for a closer look at earnings per share. Second quarter GAAP earnings were $2.58 per share, including a net earnings benefit of $0.33 per share from the combined impact of gains on divestitures, which were partially offset by incremental strategic investments and nonrepeating lost operating earnings. Excluding these items, our operating EPS was $2.25, up 8.2% year-on-year. The combination of organic growth and productivity contributed $0.08 per share to Q2 earnings.

Business transformation continues to have a positive impact on our productivity efforts. Foreign currency net of hedging reduced pretax earnings by $0.05 a share. Our Q2 tax rate was 26% versus 29.6% in the prior year, which increased earnings by $0.12 per share. The lower tax rate was driven by favorable geographic profit mix, our supply chain centers of expertise and ongoing strategic tax initiatives.

For the first half of the year, our tax rate was 25%. We now expect the full year tax rate to be in the range of 26% to 27% versus a prior range of 26% to 27.5%. Finally, lower shares outstanding and higher interest expense together had a net $0.02 positive impact to EPS.

Please turn to Slide 9 for a look at cash flow. We continue to generate solid operating cash flow as a company, which allows us to consistently invest in the business and return cash to shareholders. Second quarter free cash flow was $1.3 billion, up $378 million year-on-year. Free cash flow conversion was 85% in the quarter. And for the full year, we now anticipate free cash flow conversion to be in the range of 95% to 100% versus 95% to 105% previously. The adjustment to the high end of the range is primarily due to the gain on sale of Identity Management.

Second quarter capital expenditures were $302 million. And for the full year, we continue to anticipate CapEx investments in the range of $1.3 billion to $1.5 billion. During the quarter, we paid $701 million in cash dividends to shareholders and also returned $494 million to shareholders through gross share repurchases. In the first half of the year, we repurchased $1.2 billion in stock and now expect full year repurchases to be in the range of $2 billion to $3.5 billion versus $2.5 billion to $4.5 billion previously.

Let's now review our performance by business group. Please turn to Slide 10. Industrial, our largest business group, continued its strong growth, delivering second quarter sales of $2.7 billion, up 3.8% organically. Industrial's growth was once again broad based across all geographic areas and nearly all businesses.

Advanced materials led the way with low double-digit growth in the quarter. The automotive and aerospace solutions business grew mid-single digits in the quarter as we continue to outgrow the market. Our Heartland businesses within Industrial all posted positive organic growth in the quarter. Industrial adhesives and tapes grew mid-single digits, and abrasives and automotive aftermarket each grew low single digits. On a geographic basis, organic growth was led by Asia Pacific and the U.S.

Industrial delivered second quarter operating income of $523 million with an operating margin of 19.2%. Adjusting for incremental strategic investments, operating margins were 21.5%, down nearly 200 basis points year-on-year. Half of the decline was due to foreign currency with the remainder from mix and select pricing actions to drive volume growth. Looking ahead, we expect operating leverage in the business to improve in the second half of the year.

Please turn to Slide 11. Second quarter sales in Safety and Graphics were $1.5 billion with organic growth of 3.2%. Organic growth was led by our personal safety business, which again delivered high single-digit growth in the quarter. We continued to experience strong demand for our personal safety solutions across the world with particular strength in Asia Pacific, up double digits, followed by high single-digit growth in the U.S.

In transportation safety, we continue to take actions to improve the portfolio. In Q2, we finalized the sale of the Identity Management and tolling businesses and announced the exit of electronic monitoring. For almost 80 years, 3M has pioneered industry-leading solutions to improve road safety and mobility. We continue to focus on the rapidly changing trends in transportation safety and mobility, including the connected roadways of the future.

Finally, Q2 organic growth in our commercial solutions business was flat, while the roofing granules business declined, primarily due to tough year-on-year comps. Geographically, Safety and Graphics grew organically in all areas, led by a 9% increase in Asia Pacific. Second quarter profits in Safety and Graphics more than doubled year-on-year to $852 million, boosted by divestiture gains. Adjusting for these items and strategic investments year-on-year, operating margins were 27.1%.

Please turn to Slide 12. Our Health Care business generated second quarter sales of $1.4 billion. Organic growth was 2.5% year-on-year. Organic growth was led by a double-digit increase in drug delivery systems followed by food safety, which was up high single digits. Our medical consumables businesses, which represent the largest segment within Health Care, posted 3% organic growth in Q2.

Health Information Systems was flat year-on-year and delivered sequential improvement. Looking ahead, we expect organic growth to improve in this business throughout the balance of the year as our contract pipeline continues to build. Oral care was flat in Q2 with the first half of the year up 2%.

Geographically, Health Care was led by high single-digit organic growth in both Asia Pacific and Latin America/Canada. The U.S. grew 3%, and EMEA declined mid-single digits. We saw notable strength in China/Hong Kong and Latin America, which were both up double digits in the quarter. Health Care's operating income was $412 million, and operating margins were 28.6%. Adjusting for strategic investments year-on-year, operating margins were 30.6%.

Please turn to Slide 13. Electronics and Energy continue to lead our company with second quarter organic growth of 8.4%, resulting in sales of $1.2 billion. The electronics side of the business grew 15% organically as our team continued to drive increased penetration on many OEM platforms. For example, our Novec specialty fluids grew high teens as we continued to see strong demand for its many applications. Demand strengthened across most market segments in consumer electronics, and we continue to benefit from favorable year-on-year comps.

Our energy-related businesses were down 3% organically with electrical flat while telecom declined. On a geographic basis, organic growth was led by a double-digit increase in Asia Pacific, which is where our electronics business is concentrated. Latin America/Canada grew slightly. U.S. was flat, while EMEA declined.

Second quarter operating income for Electronics and Energy was $301 million with operating margins of 24.8%. As you can see, Q2 was another strong quarter for our Electronics and Energy business.

Please turn to Slide 14. Second quarter sales in Consumer were $1.1 billion with organic growth of 0.7%, which was an improvement versus recent quarters. We continue to see positive organic growth in 3 of our 4 consumer businesses, namely home improvement, home care and consumer health care. As expected, our stationery and office supplies business was again impacted by channel inventory reductions in the U.S. office retail and wholesale channels, although these growth headwinds were lower in Q2 versus Q1. We expect to see these channel adjustments continue but to have less of an impact in the back half of the year.

We are seeing a good return on accelerated investments in some of our key category-defining brands. For example, our Command damage-free mounting products posted strong double-digit growth, and we also delivered good growth in Scotch-Brite cleaning products. Geographically, organic growth in Consumer was led by Asia Pacific and Latin America/Canada, both up high single digits. This growth was partially offset by declines in the U.S. and EMEA.

Finally, operating income was $195 million with an operating margin of 17.2%. Adjusting for strategic investments year-on-year, operating margins were 22.2%.

Please turn to Slide 15, and I will now turn the call back over to Inge. Inge?

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Thank you, Nick. As I look upon the first 6 month of the year, I'm pleased with the performance from our global team. We are successfully executing the 3M playbook while delivering strong growth and premium returns.

On the left-hand side of this chart, you see the first-half numbers: robust earnings of $4.74 per share; organic growth of 4%; margins of more than 25%, up 130 basis points year-on-year or up 40 basis points excluding the impact of M&A and strategic investments; and a free cash flow conversion rate of 70%.

Equally important, we were active in taking action to strengthen 3M today and into the future. As you heard Nick discuss, we accelerated strategic investments in the first half, which include an incremental $75 million to support growth in core platforms. These growth investments will continue throughout the year, and they will contribute 50 to 100 basis points of growth in 2017. We also invested another $239 million in the first half to optimize our portfolio and manufacturing footprint. This is part of the 5-year plan we laid out in March of 2016 at our Investor Day in St. Paul, and we are making good progress executing that plan. These investments are important to strengthen the long-term competitiveness of our enterprise.

Beyond strategic investment, we also continue to make good progress on our 3 key levers. The first is portfolio management. And in March, we announced the acquisition of Scott Safety, which should close in the second half of this year. This acquisition will complement organic growth and further improve our position in the fast-growing personal safety market.

In the first half, we also finalized 3 divestitures and announced another 1. Ultimately, selling the businesses will allow us to focus on our biggest and best opportunities and create the greatest value for our shareholders.

Investing in innovation is the second lever. In the first half, we invested $944 million in research and development or 6% of sales. These investments support organic growth while enabling us to deliver premium margins and return on invested capital.

The third lever is business transformation, which starts and ends with our customers. At our Investor Day last month in Neuss, Germany, many of you saw the good progress we are making with the rollout of the ERP system in West Europe. Our business transformation plan is on track, and I remain confident going forward.

In summary, our team delivered a strong first-half performance. We're executing our strategies, building for the future and posting a good financial performance. As a result, today, we're raising the bottom end of our full year guidance for both earnings per share and organic growth, which you will see on Slide 16.

With respect to EPS, we now anticipate earnings of $8.80 to $9.05 per share, up 8% to 11% versus last year against the prior range of $8.70 to $9.05. Organic growth is estimated to be 3% to 5%, up from the previous range of 2% to 5%. And as you can see, we continue to expect strong results in terms of both return on invested capital and free cash flow conversion for the full year.

That concludes our prepared remarks. And with that, I thank you for your attention, and we will now take your questions.

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Andrew Kaplowitz of Citi.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division - MD and U.S. Industrial Sector Head [2]

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Nick, can you give us some more color on what's going on with your ability to price? You mentioned the electronics pricing impact in APAC, but U.S. pricing continues to drift down. You did preview price versus raws getting less positive as the year went on. It did stay positive in the quarter. But can you talk about your confidence that it will stay positive as the year continues? And [then in] negative pricing, you're seeing more choice kind of market share gain for...


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