3M Company (MMM) Management Presents at Goldman Sachs Industrials & Materials Conference (Transcript)

|
About: 3M Company (MMM)
by: SA Transcripts
Subscribers Only
Earning Call Audio

3M Company (NYSE:MMM) Goldman Sachs Industrials & Materials Conference Call May 15, 2019 9:45 AM ET

Company Participants

Nick Gangestad - CFO

Conference Call Participants

Joe Ritchie - Goldman Sachs

Joe Ritchie

[Technical Difficulty] SVP and CFO, very delighted to have you here today. Nick is going to kick it off with some opening comments [Technical Difficulty]

Nick Gangestad

Great. Thanks, everyone for being here. And Joe, thanks for hosting us.

I’d like to cover a few topics before we jump into the Q&A. And, as a reminder, here is our forward-looking statement regarding this presentation.

So in first quarter, we faced some near-term challenges, a challenging quarter. And as we discussed in our first quarter earnings call, we're moving quickly to strengthen our performance and address the challenges that we're facing. And these are the actions that have been and are underway in 3M. First, we're reducing approximately 2,000 positions in our company through both voluntary and involuntary actions and these reductions span all business groups, functions and geographies with an emphasis on corporate structure and underperforming areas of the portfolio. And on a pretax basis, we are anticipating a charge of approximately $150 million in 2019. We expect the vast majority of that to be in the second quarter and we expect annualized savings of approximately $225 million to $250 million with a $100 million of that occurring in the second half of 2019.

Beyond restructuring, we are also driving cash flow by working to reduce our inventory levels and trimming our CapEx expenditures. And importantly, we're taking these actions we also remain focused on our customer and on growth and balancing short-term pressures with the long-term success of the Company. And that's why we continue our investments in growth, which includes research and development, and our priority growth platforms that you may have heard us talk about in the past.

Now, in regards to the current quarter, what are we seeing so far in Q2? April came in very much in line with our expectations. Overall, while we’re an annual guiding company, as we look into Q2, I’ll reiterate part of what I said on the first quarter earnings call, we would not be surprised, in fact, we’d expect that Q2 is going to look a lot like Q1 with flat to slightly negative organic growth. So, organic growth in the negative 1% range would not be out of the question, which would be very similar to what we saw in Q1. And we expect earnings per share to be very similar to what we saw in the first quarter. And that's not accounting the impact of the -- before I take into account the impact of our restructuring actions. Those will be approximately $150 million or a $0.20 charge. And by the way, that $0.20 charge, and the resulting net savings in the second half of the year is included in our overall guidance that we've provided for 2019.

As far as some of the macro things we're seeing, China, automotive and electronics are three of the places where we were seeing the most noticeable near-term challenges in the first quarter. Those are largely continuing. We expect automotive production to continue to be down in the second quarter. We expect to -- we're continuing to see weaker growth in our electronics business. And China started the year in the first quarter, our China operations with negative mid-single-digit growth. And for the year, we're expecting our growth in China to be approximately flat. That implies some rebuilding as the year is going on. And what we've seen so far in the second quarter is very much in line with how we’ve guided for the full year.

Also, on our first quarter earnings call, we had two significant litigation matters related to PFAS and respirators that impacted our quarter. And those resulted in a total charge of $548 million or $0.72 a share. We increased our respiratory reserve by $313 million to address the costs of resolving all current and future expected coal mine dust lawsuits in Kentucky and West Virginia.

We also established a PFAS reserve of $235 million to cover certain environmental matters and litigation related to our manufacturing disposal of PFAS at five 3M facilities, including three in the United States and two in Europe. This reserve does not cover any product claims related to PFAS.

We also continue to work with communities to ensure that they can have confidence in the quality of their drinking water. And last Sunday, our Chief Technology Officer, Dr. John Banovetz, published an op-ad in the Washington Post communicating our commitment to work together with federal and state governments, including the EPA to adopt thoughtful regulations. If you want more information about PFAS and our litigation, I encourage you to look at our most recent 10-Q filing.

And then, the last thing I'd like to cover is Acelity. One of our strategies has been to continually review and update and strengthen our portfolio. And in November, we laid out our portfolio management strategies going forward. This includes prioritizing M&A opportunities that utilize our fundamental strengths in 3M to expand positions in attractive markets and to enable our priority growth platform. Two weeks ago, we entered into an agreement with a Acelity to acquire them. They are a leading medical technology company with solutions focused on large -- on the large and growing, advanced wound care segments in the world. It's one of our 12 priority growth platforms. And we are acquiring them for $6.7 billion.

Acelity is an excellent complement to what we already have in 3M around advanced wound care management. Acelity has been a leader and innovator in creating negative pressure wound therapy as a way to activate wounds to promote the speedy healing from a wound. And by bringing this into 3M, it will allow us to apply our fundamental strength and our global reach and our technology development to take this even further.

In 2018, Acelity delivered revenues of $1.5 billion and about 75% of their revenue is in the Americas. We anticipate on a three-year cost synergized basis that this will be -- this will be representing EBITDA levels of 11 times EBITDA. And in regards to EPS, once we close this deal, which we expect to happen in the second half of this year, we see in the first 12 months it being dilutive to GAAP EPS by $0.35, and it’s been accretive to cash EPS by $0.25.

The deal will be financed with available cash along with proceeds from the issuance of new debt. As a result of this transaction, we also adjusted our full-year guidance for share repurchases. We now anticipate repurchases in the range of $1 billion to $1.5 billion versus our prior range of $2 billion to $4 billion.

In summary, we are quite excited about this acquisition. It's one we've been working on for quite a period of time. And we are looking forward to adding their technologies, their products, and welcoming their employees to our team once this transaction has closed.

With that, I thank you for your attention. And now, let's move to Q&A.

Question-and-Answer Session

Q - Joe Ritchie

Thanks, Nick. I appreciate the opening comments there. Obviously, a lot to unpack, a lot going on within the Company today. Maybe we'll just kind of start in order of the way you presented it with the restructuring. As of the time of the quarter, the restructuring was still new, just been announced within the Company. The estimates that you had given for the year from a benefits and cost standpoint were still estimates, right? So, we're a couple of weeks removed from that or a few weeks removed from that. How much more clarity or certainty do you have on how much the restructuring is going to cost from the benefits to 3M?

Nick Gangestad

Joe, I would say based on the last two weeks and the work that was going on before that, our estimates are unchanged. We still think $150 million is our best estimate and the $225 million to $250 million on an annualized basis of benefits coming from that. I would say, everything is progressing right in the range that we laid out.

Joe Ritchie

And from a -- I know that you've mentioned that there is going to be a variety of corporate reductions as well as underperforming businesses. At the segment level, is there any more clarity where we should expect some of the restructuring to come out of?

Nick Gangestad

It will be disproportionately represented in businesses that are currently underperforming. So, in light of where we're guiding and expectation for organic growth, both our safety and industrial business and our transportation and electronics businesses, those have represented the most significant adjustment down in our growth expectations in 2019. So, those two will be overrepresented in the 2,000 employees.

Joe Ritchie

I know that for the first quarter -- I mean, I think, you said, you guys were disappointed by your own results, clearly embarking on the restructuring actions. If you could point to maybe just one or two things where -- what really surprised you at the quarter that you just weren't expecting?

Nick Gangestad

What surprised us, Joe, and I'll put it in that manner, is not where things were happening, but the magnitude that we underestimated. So, even in January, we were talking about slowdowns we're seeing in China, slowdowns, we’re seeing in electronics, as well as in automotive. And those things, clearly as entering the quarter, we had tempered our expectations on those, but we didn't temper them enough. And as the quarter went on, we could see those continuing to evolve into lower and lower growth than what we were expecting in January, causing us to then reevaluate what's the total year outlook for -- in particular those three areas.

If I go deeper, I'd say another part of this is the aspect of the amount of as we see lower demand, the compounding impact in the channel, also reducing that. That compounded it, but it was not -- it was really the underlying demand in automotive, China and electronics that was the biggest change from what we were estimating in January.

Joe Ritchie

So, I'd love for you to elaborate on the channel comments. I know that you called call it at the quarter, and whether you've seen any improvement in the channel. But then, the second question I really have is, how much of it is market dependent versus 3M-specific in terms of where you underpaced or how you underpaced in 1Q?

Nick Gangestad

So, the answer is mixed, Joe. In places like automotive, and I’ll use China, because it's the most extreme example that we saw auto builds down approximately 15% in the first quarter. We saw noticeable channel contractions going on there. And I would not call that specific to 3M. And we saw our automotive business down approximately 30% in the first quarter as the channel contraction compounded the auto build being down 15%. So, in that case, I would say that was market related. I’d say, similar dynamic in electronics.

In the case of some of our industrial and safety -- safety and industrial channel, it's hard to say how much of that would be 3M-specific versus market. In particular, in the U.S., we saw some build-up of inventory in the channels in the middle of the year, as we were preparing to go live with our ERP deployment in the third quarter. And as we entered the first quarter, we thought all of that inventory was back to the normal level. We continued in the first quarter to see further pull-downs during the channel in that. And I would call that more 3M-specific than I would call it a macro or a broader market issue.

Joe Ritchie

That makes sense. Maybe switching a little bit to Acelity for a second. So, as you mentioned on the slide and the footnote, they have filed an S-1, April 17. Talk us through how this transaction actually came together?

Nick Gangestad

As I said in my prepared comments, we've been working with Acelity for quite some time. This is a target that we’d had in mind for quite a while in our Company. And the timeline, as we were working through this, looking at the potential this could have in our Company. I know Acelity chose to file an S-1 and go that path, not going to comment on their decision to do that. I'm not going to speculate on the motivation there. But, we've been involved with them for quite some time.

Joe Ritchie

Okay, fair enough. And, one of the values, obviously, that you're talking about in the deal and plus including the 8% synergies is -- it was really just the synergies and sales, right? So, when you take a look at Acelity’s P&L, it looks like gross margins are very good. There might be some opportunity below the line. And so, is that where you're seeing predominantly the value that you're going to get in the synergies, or maybe just talk us through a little bit more on the cost take out?

Nick Gangestad

Yes. So, what I said on the first quarter -- well, I said on the call where we discussed this that we expect about an 8% cost synergy as a result of bringing these two organizations together. And that's built, Joe, by as we go through a due diligence process, examining what they bring to the table, what we have on the table around our presence, what do we see this combined organization looking like, and the structure that we’ll be needing to support this combined business in the coming years. That leads us to project here's where we see cost synergy benefits from streamlining that combined organization. We also typically have benefits that we get as we bring things into 3M and taking advantage of some of our own efficiencies, sourcing as an example, some of our technologies and processes like Lean Six Sigma improvement, and the benefits there. Those are things that lead to that 8% benefit that we expect.

The overall process in 3M is we have a strong, centralized integration management office that takes control of much of the integration aspect. And the playbook we follow is we have a clear plan as we move through the integration of what will happen, when, in order to be getting those benefits. And it will likely come on both sides. As we bring this together, some of the cost benefits will be on the Acelity side, some of the cost benefits will be on the 3M side.

Joe Ritchie

Maybe one more question for me before I open it up to the audience. You mentioned the litigation earlier, now the manufacturing disposal of PFAS does include the potential product suits, because I would imagine it's pretty hard to estimate. But, how do you give investors confidence that what you’ve reserved for today is bringing sense for the two charges that you took this quarter?

Nick Gangestad

On PFAS, the ring fence, I would call it as ring fenced around liability around our five manufacturing sites and disposal of PFAS, because that's the view where we've looked at all the discussions going on in all of the sites, all the litigation and putting our best estimate together of what we think all of those costs will be. So, that portion I would call ring fenced. What I would not call ring fenced is the product liability side. Number of cases out there around product liability where our customers have purchased PFAS containing materials, that then in itself is creating an environmental issue that's resulting in litigation. What we are saying is, we cannot estimate what that is. We don't see it as probable. We can't see a way to estimate what that is. And at this point, we're just not even speculating on what kind of amount that would be.

Joe Ritchie

Any questions from the audience? Sure, right here in front. Can you can you press your mic? There you go.

Unidentified Analyst

Question about any possible changes in sales force compensation, perhaps related to ERP? Have there been any tinkering with sales force comp?

Nick Gangestad

The only tinkering that I've seen us do and continue to anticipate is more and more of our sales compensation is based more on end customer demand versus what's going into the channel. Now, that requires us to have very good point of sale information about not just as we sell it into a distribution channel, but then where it comes out. In some places in the world we have pretty good visibility there, some places, it's less clear. So, that's been one dynamic we've been going, changing in our sales compensation.

Joe Ritchie

There's a question right there.

Unidentified Analyst

Thanks. Yes. I had just a question on the tariffs in terms of how you're running the business in terms of CapEx. So, are there -- because of the tariff uncertainly, are there some things you were thinking of doing that you're going to hold back on, or alternatively, are there some things that you're not going to do for now, but you've got a plan that if there's a deal with China and things get solved, if you will, but you'll go forward on certain things, or is it no change, business as usual? Thanks.

Nick Gangestad

I think, one thing that's important to be aware of in 3M supply chain management, and the way we choose to source and manufacturer products is we have an overall philosophy of moving our production as close to the customer as possible. So, while in China, we have a significant manufacturing base, virtually all of that manufacturing base is there dedicated to manufacturing products for our customers in China. Very little, what we manufacture in China leaves China and ends up coming back to the U.S. So, for us, there's very little tariff exposure from that -- from the way we set up that supply chain.

Two places we do have tariff exposure is our own suppliers. Some of our suppliers have their supply chain where they're obtaining parts or all of the raw material in China and then we're acquiring that to use in the United States for an example. That has a tariff impact as we negotiate with them on increased prices that they would like to pass that on to us. The other places where we are impacted is, there's often a retaliatory tariff placed on things that we take into China. And so, all-in, we're a net exporter into China from the United States. There's a number of things where we manufacture in the United States and bring it into China. And so, for the total year, we estimated that our tariff exposure as part of our total raw increase in raw material costs would be a $0.10 to $0.20 headwind. The tariff portion of that we had estimated to be approximately $100 million.

Right now, based on what we know, we still see that as a very good estimate for us that we still see ourselves in that $0.10 to $0.20 headwind range and approximately $100 million of that from the tariffs. Now, that's based on what we know and it has been formalized. More recent announcements where there's less clarity of what will really happen, that could change that number, but I don't see it having a material impact on us right now.

Unidentified Analyst

But just quick follow-up. In terms of CapEx plans, any change at all?

Nick Gangestad

CapEx plans, given our strategy around putting things as close to the customer as possible. The tariffs themselves really not impacting us. What would impact is if we see China as a lower growth environment, that can cause us to slow down some of our CapEx investments in China. In aggregate for the total Company, we started the year with a higher CapEx range and we’ve brought that down approximately midpoint to midpoint, approximately $150 million, not driven by tariffs but driven by just the fact that we're seeing a lower growth environment in 2019.

Joe Ritchie

Can you go back to PFAS for a second? I know you're not going to speculate on what the overall potential size of the reserve could be. But, in the context of the $235 million that you did reserve this quarter and the $850 million payment that you made in Minnesota, maybe just kind of contextualize how that's -- why that number makes sense today?

Nick Gangestad

The part of it’s impacted by the materiality of the manufacturer that -- quantities that we had in each of our five manufacturing sites. I’m not going to go into the amount of manufacturing each side. Clearly, our Minnesota site was the more significant source of manufacturing, others much more minor. The other piece I’d add, Joe, is we've been in the process over last decade or two of doing remediation activity in a number of these sites to be limiting the amounts of PFAS in the groundwater, so $235 million that you saw us reserving now is also on top of what we've been spending in the last two or three -- last couple decades of remediation in those regards.

Joe Ritchie

And maybe kind of switching gears a little bit. One of the hallmarks of your organization has been your ability to 1 to 2 points of price realization in the past. I think, in 2018, you got about 110 basis points of price; ‘19 you're expecting price cost I think to be pretty positive, at least 100 basis points of price. And so, with the context of a deteriorating background and pushing price through, just wondering how your conversations with your customers are actually going.

Nick Gangestad

So, what we've -- what I said is we expect -- I said a couple things. We expect about a 100 basis points of price growth this year. Many of the actions to realize that have already been put in place late in 2018 or early 2019. And also that we expect the net of price and raw materials to be a net positive to our operating income margins. Both of those still stand. We still see approximately 100 basis points of price growth this year as in the right estimate. And, that will be more than offsetting raw material headwinds that we see. So, overall, I'd say, that's playing out very much as we expected.

Joe Ritchie

And maybe just talking about the segments, and let's talk about health care for a second. Drug delivery was down pretty materially this quarter. I think, it was down about 20% organically. And I'm just wondering, from a portfolio standpoint, how do you think about some of the businesses that have been weaker for a longer period of time, and whether they will continue to stay as part of the portfolio over the long term?

Nick Gangestad

Yes. Joe, portfolio management is an ongoing process. Someone -- sometimes people ask me, like, are you done yet? And I'm like, no, we continue to evaluate our portfolios. Really, the focus is on how much of a fit is this particular product line with 3M and its fundamental strengths. So, is it leveraging our technologies, our manufacturing capability, our geographic reach, our brand? The things that we see staying in our portfolio in the long term are very good fits with what we see as our fundamental strengths. Things that continue to be under closer review, have less fits with those fundamental strengths. And it's compounded by being in a market that we don't see as long-term being as strong of an opportunity from an attractiveness to be in that market or growth that will also influence that decision. So, it’s ongoing process. We look at it with a number of businesses, and we're going to keep doing it. Of course, I'm not going to talk about any particular one that's being looked at.

Joe Ritchie

Well, it's interesting, right, because you ended up keeping Health Information Systems, and that that was clearly a positive this quarter, and has been since your decision to retain it. I'll open it up to the audience for one last question, if there is one. Right, here in the front?

Unidentified Analyst

Just one more on the ERP. I know you said there might have been a buy-in ahead of it in the U.S. that would have likely the result. What about the actual implementation of it? Have there been any disruptions due to that?

Nick Gangestad

Yes. So, we’ve deployed our U.S. customer facing site in August of 2018. And we anticipate that -- we estimate that there was about 100 basis points of total growth that was pulled forward from Q3 into Q2, as a result last year. As we've gone on, I think there's very little risk I'm under estimating -- that I'm overestimating that number. If anything, I think, could have been that amount or even higher that was pulled forward.

As far as the deployment itself, we are pleased of how the transactions are working and how information is flowing. I think, anytime you do an ERP deployment, you cannot underestimate how disruptive this is. It’s disruptive to our customers, because there's new and different ways they need to be procuring or ordering our products; it’s disruptive to our suppliers; it’s disruptive to our employees, as they have to work through new ways of doing almost every aspect of their job. So, we're still working through all of that. And so, while it's very much as we'd expect in an ERP deployment, there is an aspect of change that we're still working through. We don't think it having material impact on our business, but it is also a source of attention and energy that the organization is focusing on as we continue through that change that we're doing.

Overall, we're very pleased with how well these processes are performing.

Joe Ritchie

And, Nick, I've been asking everybody this question so far today. What are you hoping to be able to tell us 12 months from now, when you come and you return and we have a hot seat again?

Nick Gangestad

Okay. Clearly, I want to be talking about how we delivered on 2019. And because it's a top focus there, I expect that we'll be talking about our transformation effort and the continued progress we're having on that and the efficiencies we're gaining. We also will be talking about, I'm anticipating, ongoing portfolio management. By that time, Acelity will be part of our company, and we'll be talking -- I'll be talking about how pleased we are with having that as part of our portfolio and the benefits we're seeing. I think, those are the highlights I think we'll be talking about. I'll probably throw in there, priority growth platforms, our 12 priority growth platforms. I think that will be another topic of conversation 12 months from now.

Joe Ritchie

Sounds good. Nick, thanks so much for being here today.

Nick Gangestad

Great. Thanks, Joe.