3M Company (MMM) — Q3 2017 Earnings Call Transcript

Thank you, and good morning, everyone. Welcome to our third 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. Our Q4 earnings conference call will be held on January 25. Our 2018 outlook meeting will take place in New York City on December 12 from 8 a.m. to noon. Please RSVP as soon as possible. Please take a moment to read our forward-looking statement. During today's conference call, we will 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. Now, I will hand the call off to Inge.

Thank you, Bruce. Good morning, everyone, and thank you for joining us. Coming off a strong first half, our team delivered an even more robust performance in the third quarter. Organic growth accelerated to 7% with positive growth across all business groups and all geographic areas. We posted record sales and record earnings and did this while continuing to invest for the future. Total sales were $8.2 billion, an all-time high for our enterprise. As I mentioned, we delivered strong broad-based organic growth of 7% led by Electronics & Energy at 13%. Health Care grew 7% organically, followed by 6% growth for both Industrial and Safety & Graphics. Our Consumer business posted organic growth of 2%, its second consecutive quarter of positive growth. It was also good to see broad-based growth across all geographic areas, especially in developed and developing markets. Growth in the developed market was 4%, with 14% growth in developing markets. Regarding EPS, we increased earnings more than 8% to $2.33 per share, a Q3 record. We expanded margins to 25% across all business groups. In the quarter, we returned $1.1 billion through dividends and share repurchases. Beyond financial results, we are also continuing to build an enterprise that is positioned for success both today and into the future. This includes executing our three key levers, which are significant value creators. The first is portfolio management. Earlier this month, we finalized our acquisition of Scott Safety, which will further enhance our position in the fast-growing global personal safety market. The second lever is investing in innovation, with research and development at the heart of 3M. The third lever is business transformation, focusing on customer relationships. The deployment of our ERP system remains on track with West Europe nearly complete; we have also started initial deployments in the United States. That concludes my remarks, and I will now turn the call over to Nick.

Thanks, Inge, and good morning, everyone. I'll start with a recap of our third quarter sales performance. We posted strong organic growth in the quarter of 6.6%, as we continue to outgrow the markets we serve. Selling prices improved sequentially versus the second quarter and were flat year on year. Excluding Electronics, prices were up 20 basis points, marking our strongest quarterly pricing performance this year. The divestiture of nonstrategic businesses over the last 12 months reduced sales in the quarter by 120 basis points. Conversely, foreign currency translation increased sales by 60 basis points. All-in, third quarter sales in U.S. dollars increased 6% versus last year. In the U.S., organic growth was 3.6%, led by high single-digit increases in Health Care and mid-single-digit increases in Industrial. Our Safety & Graphics and Consumer businesses also delivered positive growth in the quarter. Asia-Pacific led the company with organic growth of 13% in Q3. Organic growth was 23% in China/Hong Kong and 5% in Japan. Moving to EMEA, organic growth was 4% in Q3. Finally, organic growth in Latin America/Canada was 5%. All businesses posted positive growth with Health Care leading the way. We continue to generate broad-based growth across the globe, giving us confidence in raising our full year expectations. Company-wide, third quarter sales were $8.2 billion with net income of $1.4 billion, up 7.5%. On a GAAP basis, third quarter operating margins were 25%. Gains from organic volume growth and productivity contributed 90 basis points to operating margins. Our continued focus on portfolio management is strengthening our enterprise in many ways. The combination of lower raw material costs and selling price changes added another 30 basis points. Foreign currency, net of hedging impacts, brought margins down 40 basis points in the quarter. Let's now turn to slide 8 for a closer look at earnings per share. Third quarter GAAP earnings were $2.33 per share, up 8.4% year over year. This result includes a $0.06 impact from strategic investments. Organic growth was the predominant driver, along with raw material benefits. Finally, lower shares outstanding, net of higher interest expense, was a $0.02 benefit to EPS. We posted solid operating cash flow, enabling us to invest in the business and return cash to shareholders. Third quarter free cash flow was $1.4 billion with a conversion rate of 100%. For the full year, we expect free cash flow conversion in the range of 95% to 100%. Turning to CapEx, we continue to see many opportunities to invest in growth. Third quarter capital expenditures were $325 million. In addition, we returned $701 million in dividends, up $31 million, and $380 million through gross share repurchases, with total year-to-date repurchases at $1.6 billion. Finally, we now expect full-year repurchases in the range of $2 billion to $2.5 billion. Let's review our performance by business group. Industrial, our largest business group, grew 6.1% organically in the third quarter. All businesses in Asia-Pacific posted strong growth in Q3, with our Electronics & Energy business and Safety & Graphics business showing double-digit increases. Lastly, for Consumer, organic growth grew 1.9%. Adjusting for strategic investments year on year, operating margins were nearly 26%. Excited about growth potential moving forward. Thank you.

Thank you, Nick. As I look across our enterprise, I am very pleased with our performance in the quarter and throughout the year. As a result, today we are increasing our expectation for 2017 in terms of both organic growth and earnings per share. We now anticipate organic growth of 4% to 5% versus a prior range of 3% to 5%. With respect to EPS, we expect earnings of $9 to $9.10 per share, versus a prior range of $8.80 to $9.05. This is a 10% to 12% increase year on year. As you can see, we continue to expect strong performance in terms of both return on invested capital and free cash flow conversion. Thank you for your attention. And we will now take your questions.

Good morning, guys. Just a question, sort of a top-down question. Top-line growth of 6.6%. As you think about the economic environment and overlay it with your longer-term framework, would you describe the current economic environment as average, above average, or something we can expect to achieve consistently in this environment?

Well, first of all, good morning. I think it would be difficult to judge within the five-year plan frame, but I would say it is possibly on the high end. We've adjusted our range from 2% to 5%, then 3% to 5%, now to 4% to 5%. We have very high confidence as we move into 2018, which we will discuss on December 12 in New York. The execution of our commercialization programs is going well and is broadly effective. So I lean more towards the higher end of the 4% to 5%.

Okay. And just a follow-up question. On Electronics growth that has been quite strong, can you provide more insight into what specifically drives it? I'm trying to understand how much of it is increased content in mobile devices versus participation in the Asian semiconductor cycle.

On Electronics & Energy, taking a step back, we have been strategically shifting and accelerating investments to the fastest-growing segments. Our growth is broad, especially in consumer electronics. Demand in China for performance, quality, and functionality drives our growth. The shift toward data centers, automotive electrification, and energy grids is fundamental in our success. The total market size we came from was substantial but slow growth; now we're aligning with faster-growing markets, which contributes significantly to our positive results.

So that would imply that Electronics growth is sustainable into 2018 as these structural drivers remain?

Yes, that is correct. However, technology conversions can impact quarterly performance, but overall, we are confident about the total business continuing to perform well.

Thank you very much.

Hi. Good morning.

Morning, Julian.

Hey, Julian.

Morning, Julian.

Morning. Maybe just a first question around strategic investments. Previously, you talked about that being a step-up year on year of $0.20 to $0.25 in the second half. It now appears that's somewhat less. Can you provide background on why that's happening?

Thanks for that question. I would describe third quarter performance as a good example of our business model in action, where we achieved good organic growth and strong margins while positioning 3M for future success. We remained on track for the full year expectations, and investments include core growth platforms and actions to optimize our portfolio. We are making good progress in 2017.

Understood. Thank you. And then just my second question, price and raw materials. It seems your operating margin bridge slightly picked up in Q3. Can you elaborate on that?

Most of that 30 basis points is from raw materials. Pricing for the total company was flat or up 20 basis points, excluding Electronics. We're seeing core underlying price growth, and we think pricing trends will remain sustainable despite the underlying market being challenging.

Hi, guys. Good morning.

Good morning, Steve.

Morning, Steve.

Really, really good quarter. Just following up on the Electronics commentary. You guided to about 10% for the year, which seems to imply around 7% to 8% for Q4, is that correct from an organic perspective?

Yes, Steve. Your math is sound.

Okay. You mentioned that your growth is not necessarily sustainable, especially with semiconductor sales up solidly. When you say it's sustainable, do you mean relative to an index or within a certain range?

When we say sustainable, we expect continued opportunities for penetration in consumer electronics and are reevaluating our portfolio to target faster-growing market opportunities. While quarterly fluctuations exist, our business model is functioning, giving us a solid foundation for growth.

Okay. And then one more question just on the investments and margins. R&D was a little light. Is there anything going on there?

There is no concern regarding our R&D investment. We are committed to increasing it and have made significant progress toward that goal. We continue to prioritize R&D to ensure we remain competitive in our markets and deliver innovative solutions.

Excellent, great quarter. Congratulations.

Thank you, Steve.

Thank you, Steve.

Good morning, guys. Nice quarter.

Morning, Andrew.

Thank you.

You had an easier growth comparison in Health Care, but the acceleration in growth is notable. Can you discuss if this is just due to previous spending impacting the business or an overall acceleration in Health Care markets?

We have made long-standing investments in Health Care. Our growth is due to these investments paying off, particularly in the developing economies where Health Care grew 12%. In developed markets, particularly in the U.S. and Europe, we also saw good growth. We are confident in maintaining a growth range of 4% to 6% moving forward.

For the year, we are guiding Health Care growth at 3% to 5%, and we see ourselves solidly in that range for 2017.

Thanks for that, Nick. Regarding pricing in the U.S., how much of the incremental improvements come from 3M pulling back on rebates versus improved market performance?

We've seen slight improvements in pricing in the U.S. through our business model, and while slight incremental improvements exist, we are not pulling back on our part. It's a result of the pricing environment’s growth ability. We'll discuss 2018 more on December 12.

All right. Thanks, guys. Appreciate it. Nice quarter.

Thank you.

Thank you.

I echo the sentiment of a solid, strong quarter. I want to follow up on pricing as you've discussed the need to catch up on that from earlier in the year. Could you discuss your view on where you'll see pricing pressure over the next few years?

You should think about 3M as a price leader in our categories. Our scientifically based business model drives that. We focus on providing solutions that drive productivity and efficiency. We do not compete on a commoditized basis; we create differentiated value and deliver better outcomes for our customers. Our commitment to science and technology continues to keep us competitive and relevant.

Could you elaborate on your growth initiatives and how we should quantify the long-term opportunity around electrification?

We have significant opportunities in the electrification trend, particularly related to automotive. Our strong technologies in Electronic & Energy play crucial roles. For us, this is not just about electrical systems, but about overall traffic safety that aligns with automotive trends. We foresee considerable growth potential from these initiatives.

Good morning, guys. Thank you. Inge, you seem to have found success in China, a market that was challenging previously. What do you attribute this success to? Have you changed your sales and marketing strategy?

We've been present in China for a long time and made significant investments. The demands for performance, quality, and functionality from local consumers and OEMs drive our growth. Our brands are strong, and we have focused on producing products that are relevant to the local markets. As local incomes rise, we see increased purchasing of 3M's products. We're capitalizing on consumer demands and recent mega trends in air quality, which align with our strengths.

To follow up, you've been working on getting more locally designed products across regions. How do you manage to avoid duplication while ensuring development is efficient?

We have a Senior Vice President managing our R&D structure globally to minimize duplication. We focus our research efforts in specific centers while allowing localized development to cater to regional needs. Any successful solutions in local markets can also be replicated across other regions. The evidence lies in our outcomes. To wrap up, our team executed well across the enterprise and delivered another strong performance in the third quarter, with robust organic growth, increased earnings per share, and rising margins. The 3M playbook is working, and we are well-positioned moving forward. Thank you for your participation, and I look forward to seeing everyone on December 12 in New York for our outlook meeting.