3M Earningcall Transcript Of Q2 of 2024
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president and chief financial officer. Bill and Monish will make some formal comments, then we'll take your questions. Please note that today's earnings release and slide presentation accompanying this call are posted on the home page of our Investor Relations website at 3M.com. Please turn to Slide 2. Please take a moment to read the forward-looking statement. During today's conference call, we will 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 will 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 3 and I'll hand the call off to Bill. Bill? William M. Brown -- Chief Executive Officer OK. Thank you, Bruce, and good morning everyone. This morning we reported second-quarter results with non-GAAP earnings per share of $1.93, up nearly 40% with 1% organic revenue growth. Adjusted free cash flow was $1.2 billion with conversion of 109%. I'd like to thank the 3M employees for all their hard work in delivering solid second-quarter results. Monish will provide further details on the quarter and then I'll wrap up our prepared remarks with guidance for the year before opening the call to Q&A. I've now been in the job for nearly three months and have been busy visiting a number of our factories and labs, as well as taking a fresh look at our strategy and how we're executing against it. As you know, 3M has been undergoing a lot of change in the past few years following COVID, most recently with a successful spinoff of the healthcare business executing on a significant restructuring effort and working to mitigate risks, including discontinuing PFAS manufacturing by the end of 2025 and settling legal matters. You've also seen a number of changes to our organizational model, shifting from a geographic to a global business unit structure and centralizing our global supply chain activities under one senior leader. Collectively, this has been a massive transformational change for 3M, and the team has executed really well. As a result of these efforts, you're seeing the benefits in operating margin expansion, strong cash generation and a solid balance sheet with low leverage ratios, and an incrementally more positive view from the rating agencies. Credit to Mike and Monish for their steady hand in guiding the company through these changes. But my job is to look forward and while much progress has been made, we have more to do including navigating PFAS-related matters where fortunately we have a strong, terrific team managing the exit and our ongoing legal matters. As I see it, we're still in the early innings of our operational excellence journey and we haven't yet cracked the code on organic growth, which I know is essential to creating shareholder value. So my top priorities are; number one, driving sustained top-line organic growth; number two, improving operational performance across the enterprise; and number three, effectively deploying capital. On the first priority, I believe that the company has significant organic growth opportunities as we participate in end markets with favorable secular trends and have a strong foundation and long history in material science innovation. However, as you well know organic growth has been below market indices and peers over several years and up only about 1% year to date. Driving sustained organic growth requires both getting more out of R&D, as well as improving commercial excellence. As I've gotten into the details, what I've learned is that ex-Solventum R&D investment for core 3M, which is running about $1 billion per year, or about 4.5% of revenue, has been flattened nominally over the past five years and down on a real basis as the focus was on investing in and strengthening the healthcare business. And within the lower spend, the amount we invest on new product development has declined even further as the company shifted more dollars to efforts to exit PFAS manufacturing and work to reduce supply chain cost and resolve COVID-related sourcing constraints. As a result of the decline in investment, along with a strategic shift to fewer, but larger innovation opportunities, the number of and revenue from new product introductions has steadily declined over the past decade. The simple fact is that our products are aging. While we've been shifting our portfolio toward higher growth markets like auto electrification, industrial automation, data centers and semis, climate tech, and others, these efforts aren't material enough today to offset erosion in our core. They remain, for the most part, attractive growth platforms, and we need to continue to balance investing appropriately in markets that are evolving quickly, while also investing incrementally to sustain the core products we have today. But before we make any adjustments to our R&D budget, I want to first explore opportunities to get more from what we currently spend. For example, improving the velocity of our new product development process and increasing the effective capacity of our engineers by eliminating bottlenecks and non-value added work, and over time, redeploying those currently working on PFAS exit activities to growth initiatives. With enhanced data transparency and a more coordinated governance process, we can improve R&D effectiveness by deploying resources on the highest return projects. These efforts are essential to reinvigorating the 3M innovation machine but will take time to bear fruit. So in the near term we have to focus on commercial excellence to sell more of what we currently offer, and that means better sales force and distributor effectiveness, targeted marketing, optimized pricing, and much better execution at the customer interface, in particular, on time, in full performance, which is a key part of my second priority, operational performance. We have a terrific Ops leadership team in place, executing on a number of opportunities, and I want to give you some color of what I'm seeing so far. I've been looking at our manufacturing and distribution network to understand our global supply chain and distribution capabilities. I see opportunities to reduce complexity, drive lean manufacturing and logistics, improve supply chain management, lower yield loss, and increase service levels with lower inventory. While our network of 110 factories and 95 distribution centers have historically served 3M well, it is incredibly complex and interconnected, with most SKUs we produce touching multiple factories before reaching the customer. For example, a command strip touches five factories and two distribution points before it hits the store shelf. This extends cycle times, increases goods in transit, and drives up logistics and freight costs. In lean manufacturing and logistics, we're developing a consistent metric around operating equipment efficiency or OEE, to increase equipment utilization and rein in capital spending and mapping modes and flows to lower freight and distribution costs. In supply chain, we have significant opportunities to improve our sourcing effectiveness. We have more than 25,000 direct and indirect suppliers, including nearly 4000 contract and component manufacturers, yet more than 80% of our raw materials are sole sourced. We haven't been holding our suppliers accountable to the same quality and delivery standards as our customers hold us to, and we're only beginning to leverage our scale to reduce cost. Relative to yield loss, our raw material waste is running close to 5% of cost of goods sold, due in part to how we design and manufacture our products, but also due to inefficient production scheduling and changeovers. And finally, we have too much inventory at about $4 billion in 102 days at the end of Q2 and yet our service levels are only in the mid-80s. Our bottoms-up analysis indicates we should be closer to 75 days of inventory or lower, which would imply about $1 billion cash opportunity over time while we drive on time in full above 90%. My third priority is effectively deploying capital, and our approach remains the same as it's been investing in R&D and capex to fund organic growth, paying an attractive dividend which we just recalibrated with the spin of Solventum, maintaining a strong balance sheet, and using excess capital for M&A or share buybacks. We repurchased about $400 million in stock in the second quarter and have the capacity to do more in the second half and next year. While no acquisitions are on the near-term horizon, I'll be taking a fresh, dispassionate look at our portfolio to determine if any assets have greater value owned by others, and along the same line, what assets might be a good fit for 3M. I don't have anything further to say on that today, but you can expect to hear more from me regarding portfolio prioritization as I deepen my understanding of our businesses and end markets. So for the past three months, it's been pretty busy with a lot still to learn. I think we have a good foundation to build upon and believe that this focus on fundamentals, back-to-basics approach will drive value creation. I'm encouraging everyone at 3M from top to bottom to every day challenge the status quo and the way we've done things in the past, to act with speed and urgency and to off-board those things that distract us from growing, innovating, and executing for customers and shareholders. And with that, I'll turn it over to Monish to cover the quarter and I'll come back to discuss guidance. Monish? Monish D. Patolawala -- President and Chief Financial Officer Thank you, Bill, and good morning everyone. Please turn to Slide 4. I would like to take a moment to briefly remind you of a few items that we highlighted during last quarter's earnings call. Beginning with the second quarter, our results for business segment operating income includes prospectively the impact of dissynergies or stranded costs previously associated with Solventum. Therefore, for historical pre-spin periods presented, the dissynergies are reflected in corporate and unallocated. In addition, we added a new operating category named Other for Solventum transition service agreement activity. Other includes our Q1 cost associated with supporting the agreements for which 3M started to be reimbursed for in April. And finally, corporate and unallocated incorporates the commercial agreements between 3M and Solventum that started on April 1 and retrospectively picks up certain operations of the former healthcare business retained by 3M. Turning to our second-quarter performance, we posted solid adjusted results, including sales of $6 billion, operating margins of 21.6%, earnings per share of $1.93, and free cash flow of $1.2 billion. We delivered adjusted organic growth of 1.2% or up 2.4%, excluding geographic prioritization and product portfolio initiatives. These results reflect the trends that we have previously discussed, including strong growth in electronics, mixed industrial end markets, and continued softness in consumer retail discretionary spending. We had another strong quarter of execution with adjusted operating margins expanding 440 basis points year on year, and delivered adjusted free cash flow of $1.2 billion with conversion of 109%. Please turn to Slide 5. On an adjusted basis, we delivered operating margins of 21.6% up 440 basis points, and earnings of $1.93 per share, up 39% versus last year's second quarter. Our second-quarter year-on-year performance was driven by organic growth, productivity, strong spending discipline, and restructuring savings which combined benefited operating margins by 310 basis points and earnings by $0.31 per share. In addition, income from the transition services we are providing to Solventum increased margins by 50 basis points and earnings by $0.05 per share. These benefits were partially offset by stock-based compensation which was shifted into the second quarter due to the spin of Solventum. This was in line with what we discussed during our first-quarter earnings call. This change in timing negatively impacted operating margins by 200 basis points and earnings by $0.18 per share versus last year's second quarter. Lower year-on-year restructuring charges were a benefit of 270 basis points to margins and $0.23 earnings to earnings. For the second-quarter restructuring charges were $44 million, which were lower than anticipated. For the full year we continue to expect pre-tax restructuring charges in the range of $250 million to $300 million. Foreign currency was a negative $0.04 per share impact as a result of the stronger U.S. dollar. Acquisition and divestitures were a benefit of 10 basis points to margins and $0.03 to earnings year on year. This benefit is related to last year's second-quarter reconsolidation of Aearo Technologies along with the commercial agreements between 3M and Solventum. Below the line items benefited earnings by a combined $0.14 per share. This benefit was primarily due to increased interest income year on year on a higher cash balance due to in part by cash proceeds received from the spin of Solventum. Taking into account our first half of the year performance, we now expect our full-year non-operating expense to be in the range of $50 million to $75 million versus a prior range of $75 million to $100 million. A quick comment on corporate and unallocated and other before moving on to cash flow, Q2 corporate and unallocated sales were $86 million with a $2 million adjusted operating loss. Year to date, corporate and unallocated sales were $112 million with an adjusted operating loss of $73 million. This is in line with our full-year anticipated sales range of $225 million to $275 million with a forecasted adjusted operating loss in the range of $125 million to $175 million. Our Other category had operating income of $37 million which reflects the level of activity and effort to support the successful spinout of Solventum. Year to date Other had an operating loss of $28 million which is in line with our full-year expectation of flat to a loss of $25 million. Please turn to Slide 6. Second-quarter adjusted free cash flow was $1.2 billion. Our second-quarter performance was driven by strong operating income, lower capex spending partially offset by higher working capital. Adjusted capital expenditures were $250 million in the quarter as we continue to invest in growth, productivity, and sustainability. During the quarter we returned a total of $800 million to shareholders split equally between dividends and share repurchases. And finally, net debt at the end of Q2 stood at approximately $3 billion. These strong results build on our track record of robust cash generation. For the first half of the year we have generated $2 billion of adjusted free cash flow. Our strong capital structure continues to provide us the financial flexibility to invest in our business, return capital to shareholders, and meet the cash flow needs related to legal matters. Please note that in the month of July we will make total combined payments of $3.7 billion related to the Public Water Supplies and Combat Arms settlements. Before I move on to our business segment performance, I want to highlight a couple of items for your awareness that were excluded in arriving at our Q2 adjusted results. First, note that we reached settlements of approximately $120 million with insurance carriers related to combat arms. We remain in discussion with multiple carriers and anticipate additional future recoveries. Second, during the quarter we incurred a non-cash charge of approximately $800 million related to a $2.5 billion pension risk transfer on a portion of our U.S.-defined pension obligation with Met Tower Life. This action helps us to reduce risk and administrative fees related to our U.S. pension plan. Please turn to Slide 7. Starting with our Safety and Industrial business, which posted sales of $2.8 billion, up 1.1% organically. Industrial Adhesives and Tapes posted mid-single-digit organic growth driven by strength in Bonding Solutions for Consumer Electronic Devices. Personal Safety and Automotive aftermarket grew low single digits. Electrical markets was up slightly while roofing granules was flat due to unplanned customer manufacturing challenges. And finally, we experienced year-on-year organic sales declines in Abrasives and Industrial Specialties. Geographically, industrial markets grew low single digits in the U.S. and Asia Pacific, while EMEA was down low single digits. Overall, industrial end-market demand continued to be mixed in the quarter as end user and channel remained cautious. Adjusted operating income was $623 million with adjusted operating margins of 22.6%, up 40 basis points year on year. This performance was driven by higher sales volume benefits from ongoing productivity and restructuring actions and lower year-on-year restructuring charges. These benefits were partially offset by the timing of stock-based compensation and cost inefficiencies due to the spin of Solventum. Moving to Transportation and Electronics on Slide 8, which posted adjusted sales of $1.9 billion, or up 3.3% organically. Our electronics business outperformed the market up low double digits organically as we continued to gain spec in wins on consumer electronic devices and in semiconductor manufacturing. Our auto OEM business increased nearly 5% in Q2 versus a 0.5 point decrease in global car and light truck bills. Looking at the first half of the year, our auto OEM business was up 9% organically versus a flat global build rate of cars and light trucks as we continued to gain penetration on new platforms. Looking at the rest of Transportation and Electronics, advanced materials grew mid-single digits organically and commercial branding and transportation was down low single digits year on year. Transportation and Electronics delivered $426 million in adjusted operating income, up 16% year on year. Adjusted operating margins were 22.3%, up 250 basis points year on year. The team achieved this result through strong leverage on electronics volumes, ongoing benefits from productivity and restructuring actions, and lower year-on-year restructuring charges. Partially offsetting these benefits were the timing of stock-based compensation grants and cost inefficiencies due to the spin of Solventum. Turning to Slide 9, the consumer business posted second-quarter sales of $1.3 billion. Organic sales declined 1.4% year on year with continued softness in consumer discretionary spending. This included a 2.7 percentage point impact from portfolio and geographic prioritization. Home Improvement grew mid-single digits, Consumer Safety and Wellbeing grew low single digits, Packaging and Expression declined low single digits, while home and auto care declined mid-single digits organically. Geographically, the U.S. was up slightly, Asia Pacific was down mid-single digits and EMEA was down high single digits. Consumer second quarter operating income was $219 million, down 7% compared to last year with operating margins of 17.4%, down 80 basis points year on year. Operating margin performance was driven by lower volume and timing of stock-based compensation grants along with the cost inefficiencies due to the spin of Solventum. Partially offsetting these headwinds were benefits from lower restructuring charges. Before I turn it back over to Bill, I want to take a moment to thank the 3M team for the tremendous progress they have made positioning the company for success. I am very proud of the relentless focus our teams have brought to create value by driving performance through our improved productivity and efficiency, spinning out of our healthcare business and reducing risk and uncertainty by managing legal matters. I am confident that under Bill's leadership, the team will continue to build on this momentum to create consistent value for our people, our customers and our shareholders in the years to come. I would also like to thank all the analysts and investors for our rich discussions and engagements over the last four years. With that, please turn to Slide 10 and I will turn it back over to Bill for an update on our guidance. Bill? William M. Brown -- Chief Executive Officer Thanks, Monish. Given the strong operational execution in the first half of the year, we're raising the bottom end of our full-year adjusted earnings guidance by $20 to a range of $7 to $7.30 versus $6.80 to $7.30 previously, now up 16% to 21% year on year. Full-year adjusted operating margins are now expected to be up 225 to 275 basis points. Full-year adjusted organic growth remains unchanged at flat to up 2% with expectations for second-half organic growth in line with first-half performance at the midpoint. While significant macro uncertainty remains, our business segment and market trends are largely playing out as expected. Year-to-date Safety and Industrial organic growth is approximately flat versus a full-year expectation of flat to up-low single digits. We expect that industrial end markets will remain mixed as channel partners and end customers continue to remain cautious on overall demand trends. On an adjusted basis, transportation and electronics is up nearly 5% organically in the first half versus a full-year expectation of up low single digits. Strength in the first half was due in large part to consumer electronics along with automotive. We continue to monitor auto build rates along with consumer electronics demand trends for the back-to-school and holiday season. And finally consumer is down nearly 3% organically through the first half of the year versus a full year expectation of down low single digits. We continue to expect that consumer retail discretionary spending on hardline goods to remain muted in the balance of the year. Before we'd open up to your questions, I would like to take a moment to recognize and thank Monish for all his contributions and impact on 3M over the past four years. While I've only had a short time working with him, he has been a strong partner and has helped me get up to speed on the company, and I've enjoyed working with him. I appreciate everything he has done to navigate through a number of challenges and to make 3M stronger along the way. With that, let's open the call to your questions. Operator Questions & Answers: |
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