3M Company (MMM) — Q1 2019 Earnings Call Transcript

Thank you and good morning everyone. Welcome to our first quarter 2019 business review. With me today are Mike Roman, 3M’s Chief Executive Officer, and Nick Gangestad, our Chief Financial Officer. Mike and Nick 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. Please turn to Slide 2. Before we begin, let me remind you to mark your calendars for upcoming earnings calls on July 25, and October 24. Please take a moment to read the forward-looking statement on Slide 3. 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. Finally, please note that throughout today’s presentation, we will be making references to certain non-GAAP financial measures. In particular measures which exclude the impact of the Tax Cuts and Jobs Act and significant litigation-related charges. Reconciliations of the non-GAAP measures can be found in the appendix of today’s presentation and press release. Please turn to Slide 4, and I’ll hand it off to Mike.

Thank you, Bruce. Good morning everyone and thank you for joining us. The first quarter was a disappointing start to the year for 3M. We continued to face slowing in several key end markets, which impacted both growth and margins, and our operational execution fell short of the expectations we have for ourselves. Today I will lay out a number of aggressive actions we are taking to drive productivity, reduce costs and improve cash flow, as we manage through challenges in some of our end markets. In addition, I will provide an update on two litigation issues that have impacted our results and provide updated guidance for the full year. I will also discuss the realignment of our business groups that we announced last month, which will enable even greater growth and operational efficiency. Please turn to slide 5 for a summary of our first quarter numbers. Organic growth company-wide was minus 1%, lower than we anticipated. We saw end market softness in China, Automotive and Electronics, which we have discussed throughout the quarter. We also faced channel inventory adjustments, which negatively impacted several of our businesses. With respect to EPS, we posted adjusted earnings of $2.23 per share, down 11% year-over-year. This excludes significant litigation charges related to the PFAS and respirators, which I will discuss later in my remarks. Underlying margins were 21% in the quarter, down 160 basis points with adjusted income of $1.7 billion. Our earnings and margin shortfall was due to a combination of two things. First, negative organic growth in the quarter and second, weak productivity, especially in our Industrial related businesses within Asia Pacific and the United States. As the actions we took were not sufficient to offset the broad-based softening we faced in those markets as the quarter progressed. Please turn to slide 6. We are moving quickly to strengthen our performance and address the challenges we face, and the actions on this slide are underway. First, we are reducing approximately 2,000 positions through both voluntary and involuntary actions. Reductions will span all business groups, functions, and geographies with an emphasis on corporate structure and underperforming areas of the portfolio. On a pre-tax basis, we will take a charge of approximately $150 million in 2019, and we expect annual savings of approximately $225 million to $250 million, with $100 million this year. Job reductions are never easy, but they are necessary to make us stronger and a more competitive enterprise as we move forward. Beyond restructuring, we are also driving cash flow by reducing inventory levels and accelerating actions on indirect costs. Importantly, while we take these actions we remain focused on our customers and balancing short-term pressures with the long-term success of 3M. That is why we will continue our investments in growth, which includes research and development and our priority growth programs. This is a playbook we know how to execute and we are confident it will enable us to maximize value for shareholders as we work through the market slowdowns and our related actions, positioning us for strong growth as our markets recover. Please turn to slide 7. As I mentioned earlier, two significant litigation matters related to PFAS and respirators impacted our quarter and resulted in a total charge of $548 million or $0.72 per share. We increased our respiratory reserve by $313 million to address the costs of resolving all current and 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 the manufacture and disposal of PFAS at five 3M facilities, including three in the United States and two in Europe. This reserve does not include any product claims related to PFAS. We continue to work closely with the EPA and other regulatory bodies to support science-based regulations of these chemistries. We also continue to work with the communities we serve to ensure they can have confidence in the quality of their drinking water, and additional details will be available in our upcoming 10-Q filing. Please turn to slide 8 for an update on our 2019 guidance. While we remain positive on the global macroeconomic environment, growth conditions in certain markets have been slower than anticipated going into the year. As a result, today we are updating our range for organic growth to minus one to plus two percent, against the prior range of one to four percent. In addition, we anticipate adjusted earnings of $9.25 to $9.75 per share, which includes the restructuring impact versus the previous range of $10.45 to $10.90. We now expect a return on invested capital of 20% to 22% against the prior range of 22% to 25%. We continue to anticipate a free cash flow conversion rate of 95% to 105%. I'll come back to make some comments on our new business group alignment after Nick takes you through the details of the quarter.

Thank you, Mike and good morning, everyone. Please turn to slide 9. Organic sales declined 1.1% in the first quarter, with volumes down 200 basis points and selling prices up 90 basis points. The net impact of acquisitions and divestitures reduced sales by 50 basis points. While foreign currency translation was an additional 3.4 percentage point headwind to sales. All-in, first quarter sales in U.S. dollars decreased 5% versus last year. Geographically, the U.S. declined 40 basis points organically, Consumer and Electronics and Energy grew low-single digits, while Industrial, Safety and Graphics, and Health Care declined. Asia Pacific was down 3.6% organically in Q1, impacted by the slowdown in China, Automotive and Electronics markets. Health Care delivered positive high single-digit organic growth in the quarter, while Industrial, Consumer and Electronics, and Energy declined. Organic growth was down 4% in China/Hong Kong against an 11% comparison a year ago. Japan organic growth declined 7%, or excluding Electronics increased 2%. Latin America/Canada and EMEA each grew 1% organically in the quarter. Please turn to slide 10 for the first quarter P&L highlights. Company-wide first quarter sales were $7.9 billion, with adjusted operating income of $1.7 billion and adjusted operating margins of 21.4%. On the right-hand side of this slide, you can see the components of our margin performance in the first quarter. Declines in organic volume and weak productivity reduced margins 180 basis points year-on-year. Productivity challenges were most pronounced in our Industrial-related businesses within Asia Pacific and the United States. Acquisitions and divestitures combined brought down margins by 40 basis points, primarily driven by our acquisition of M*Modal, which closed in February. Higher selling prices continued to more than offset raw material inflation contributing 30 basis points to first quarter margins. And finally, foreign currency net of hedging impacts increased margins by an additional 30 basis points. Let's now turn to slide 11 for a closer look at earnings per share. First quarter adjusted earnings were $2.23 per share, down 11% year-over-year. As you see, a number of factors impacted first quarter earnings. Most significantly, negative organic growth and weak productivity reduced per share earnings by $0.19 in the quarter. This was notably different from our outlook in January. The rest of our EPS factors are in line with our original expectations. Acquisitions and divestitures combined reduced first quarter earnings by $0.07 per share versus last year. Foreign currency net of hedging was an additional $0.05 per share headwind in the quarter. As expected, our underlying tax rate increased year-on-year, which reduced Q1 earnings by $0.05. And finally, we reduced average diluted shares outstanding 4% versus Q1 last year, adding $0.09 to per share earnings. Please turn to slide 12 for a look at our cash flow performance. First quarter free cash flow was $657 million, with a free cash flow conversion rate of 74%, which includes a 24 percentage point benefit from the litigation-related charges. First quarter capital expenditures were $391 million, up $87 million year-on-year. For the full year, we now anticipate CapEx investments in the range of $1.6 billion to $1.7 billion versus a prior range of $1.7 billion to $1.9 billion. We increased our first quarter per share dividend by 6%, resulting in $830 million in cash dividends paid to shareholders during the quarter. Gross share repurchases were $701 million in the quarter, and we continue to expect full year repurchases in the range of $2 billion to $4 billion. Please turn to slide 13, where I will summarize the business group performance for Q1. Please note additional business group performance details can be found in the appendix of this presentation. As mentioned earlier, throughout the quarter we continued to see soft end market trends in China, Automotive and Electronics, along with channel inventory adjustments. These trends primarily impacted our Industrial, Safety and Graphics, and Electronics and Energy businesses. Our Industrial business saw broad-based slowdown across most of its portfolio, posting an organic sales decline of 2.8% to start the year. This slow organic growth within Industrial was most pronounced in our automotive business. Our automotive OEM business was down 9% year-on-year, impacted by a 6% decline in first quarter global car and light truck builds, along with channel inventory reductions, particularly in China. A positive note, advanced materials continued to deliver strong organic growth in the quarter, up high single digits. On a geographic basis, Industrial's organic growth was led by 1% increases in both Latin America/Canada and EMEA, while the U.S. declined 2% and Asia Pacific declined 8%. Industrial's first quarter operating margins were 20%, down 280 basis points, impacted by sales declines and weak productivity. Moving to Safety and Graphics, first quarter sales were flat organically against last year's 7% comparison. Personal Safety continued to deliver solid results in Q1, up 3% organically, while each of the other three businesses declined. Geographically, organic growth was led by Latin America/Canada and EMEA, each up 2%. Asia Pacific was flat, while the U.S. was down 3%. Safety and Graphics first quarter operating margins were 23.2%, down 380 basis points. The year-on-year operating margin decline included a negative 110 basis point impact from a gain on a divestiture last year, along with slow growth and weak productivity. Next our Health Care business was up 1% organically in the first quarter. Holding back growth in Health Care was the continued softness in our drug delivery business, down nearly 20% organically in the first quarter, which negatively impacted overall Health Care organic growth by nearly 2 percentage points. Organic growth was led by food safety, up high single digits followed by health information systems up mid-single digits, while medical solutions and oral care were each up low-single digits organically. On a geographic basis, Asia Pacific led the way up 7%, with EMEA up 3%. The U.S. declined 3% impacted by drug delivery. Health Care's first quarter operating margins were 28.1%, which included a negative 230 basis point impact from the Q1 acquisition of M*Modal. Shifting to the Electronics and Energy business, organic sales declined 3% in the first quarter. The Energy side of the business grew 5%, while the Electronics-related businesses were down 6%, with declines in both display material systems and Electronics material solutions. Electronics-related growth was impacted by soft end market demand in Consumer Electronics and factory automation, along with channel inventory adjustments. On a geographic basis, organic growth was led by a 2% increase in the U.S., while Asia Pacific declined 5%. First quarter operating margins were 23.8%, down 110 basis points year-over-year. Lastly, first quarter organic growth for the Consumer business was 1%. Sales grew in our home improvement business, up 3% organically, while home care and consumer health care declined. Looking at Consumer geographically, organic growth was led by a 3% increase in the U.S., with particular strength in our Filtrete and command brands. EMEA declined 1% as we continued to adjust our portfolio in this region and Asia Pacific declined 3% impacted by lower Consumer demand for respiratory solutions. Consumer's operating margins were 19.5% in the first quarter. That wraps up our review of first quarter results. Please turn to slide 14, and I'll hand it back over to Mike to discuss the business group realignment.

Thank you, Nick. Earlier I laid out actions we are taking to address our near-term challenges. At the same time we are continuing to build 3M for the long run. Effective April 1, we moved from five to four business groups in order to better serve our customers and better align our businesses to their markets. The new business groups are organized around customers and go-to-market models and include Safety and Industrial, Transportation and Electronics, Health Care, and Consumer. This realignment will enable us to accelerate growth, maximize value across the portfolio, and take greater advantage of our transformation progress. It will also further streamline the organization and help us achieve the 200 to 300 basis points of margin expansion that we laid out last November as part of our five-year plan. We will start reporting results under this structure in the second quarter. Please turn to slide 15, and I will take you through our 2019 guidance for the new business groups. We expect organic growth to be led by Health Care with a range of 2% to 4%, followed by Consumer at 1% to 3%. Organic growth in Safety & Industrial is expected in the range of minus 1% to plus 2%, with Transportation & Electronics at minus 3% to flat. That wraps up our prepared remarks. In summary, while our recent performance is disappointing, our business model remains strong and we are making the necessary changes to accelerate 3M into a stronger future. Thank you. And we will now take your questions.

Good morning, guys.

Morning, Andrew.

Just a question on margins. I think the last time you had this kind of revenue decline, as I look at my model was sort of 4Q ‘15 and 1Q ‘16 and sort of the operating leverage impact was a lot less I think in 1Q ‘16 margins actually went up. So I'm just trying to understand what happened with the margin decline in the quarter and specifically also, as I look at the gross margin, what surprised me once again looking at my model, the last time you had gross margins that low I think was 4Q ’08 or 1Q ‘09, so that’s very odd? Thank you.

Thank you, Andrew. Maybe I’ll start and I'll ask Nick to give some more detailed comments. The two drivers of that, one is the organic growth and the organic growth as we talked about was led by China, Automotive and Electronics, which are strong gross margin businesses for us globally. So that was one of the contributing factors. And then the adjustments that came in the channel, along with that slowing growth in those markets, that drove challenges for us in productivity in the plants. And we took actions to adjust our production levels and our costs there, but we didn't get ahead of it. So those were a couple of the big contributor really driven off of that slowing the majority of that slowing from those end markets.

Yes. Andrew, a couple things to add in there. As we were going through the quarter and seeing lower volumes and we of course adjusted the output coming out of our factories. So for the first quarter, compared to the first quarter last year, we were seeing the output in our factories down between 4% and 5%. Unfortunately we did not pull spending down proportionately. Our spending was down about 1% in our factories during that time. And that had a negative impact on our margin. Also on the - in there was the impact of a bit of a geographic mix, if you look at where we make higher margins and lower margins, the declines that we saw in Asia Pacific had an outsized impact on our margin this quarter.

Andrew, I would also add, we - as I said in my speech, we didn't respond aggressively enough to what we were seeing. And so we’re behind the curve as we came through the quarter. That's why we're stepping in aggressively with the actions that we are…

Let me ask the question maybe another way. We were surprised I think the Asia top line growth was fairly well telegraphed, maybe Japan surprised a little bit, but it's North American decline that also surprised me. And you continued sort of - you did note weak productivity in North America multiple times. And I was just wondering, how much - and I know we sort of finished the customer-facing ERP rollout. Can you just give us an update? Are you rolling out on the factories your key factories in North America, are you rolling ERP on the manufacturing floor, and is that disruptive? Thank you.

Andrew, just to update on the ERP, we've actually been very pleased with the success that we've had in the deployment in the U.S., and it has been around the businesses and not deployed to the factory level at this point. It's improving every month in our performance and what we can deliver to our customers. So that's been something that's been going well for us. When you look at the U.S., the growth, - organic growth in the U.S. was led by Industrial business, and really the automotive OEM and aftermarket businesses. There are some pockets in Safety & Graphics. And so the same kind of comments I had as as we saw slowing growth and some of the channel reactions, our production levels and our productivity didn't get ahead of it, and that was an important part of what we saw in the U.S. There are some other pockets. There are some pockets in Health Care with drug delivery in the U.S. that also contributed to that. But that gives you the background in the U.S.

Okay, thank you.

Thanks. Good morning, everyone.

Good morning, Joe.

So I'm just thinking about the organic growth guidance for the year of minus one to plus two, obviously slower start towards the low end to start the year. I guess, I'm just – as I'm thinking about how you guys actually get towards that higher end of the range as we progress through the year. I'm just curious like did trends get any better as we exited the quarter? I know comps get tougher as we progress through the year. I'm just trying to like put some context around that guidance for the year?

Yes. So Joe maybe I'll start. The – it was led by the markets that we called out and the channel reaction to some of that. That doesn't end up being an all year action. That is something that happens pretty quickly. So we don't see that necessarily be a contributor as we go through the year. And some – we do see some outlook for improvements in those markets. Health Care we have talked about challenge, we see with drug delivery being a headwind for us in the first half of the year and that gets better as we go through the year. Consumers basically at the bottom end of their range and the sellout remains strong. And in Safety and Graphics, we have a couple of pockets there. Our personnel safety business is off to a strong start to the year. And so up mid-single digits or low- to mid-single digits and we expect that to continue. The other pockets are more project delays in particular businesses and we expect those to improve as we go through the year. So it's really taking a look at each of those businesses and the guidance that we gave to those fits with Q1 and then where we see the rest of the year.

And Joe on the comp issue consistent with what we've been saying we see second quarter as our toughest comp and third quarter as our easiest comp and that's primarily driven by what we had talked about a year ago as far as the timing of revenue related to our U.S. ERP go live. So we saw almost 6% organic growth in the second quarter last year followed by 1.3% in the third quarter. So those are the two where we see the comps differentiating. All-in we saw the – we saw and we continue to see the first half as a slightly tougher comp for us than in the second half of the year.

Okay. Got it. That's helpful. And if I could just follow up just on the margins for a second. So taking a look at your gross margins for the quarter. It's hard for me to go back into history and see a time where gross margins were down as much year-over-year. And Nick you referred to it a little bit when you responded to the lower growth environment in your response from a cost-out perspective at the factory level. I just want to understand that a little bit better because it's just historically this hasn't part of the hallmark of how you guys have executed.

Yes Joe. Just one thing I think I need to make sure is clear with you and with everyone. In the gross margin on a GAAP basis is a $235 million charge related to PFAS. So in the numbers that you're seeing there on our GAAP results, not all of that hit SG&A, other $235 million of that is recorded in gross margin. And Andrew that may go back to your earlier question too. So that's maybe when you're looking at our GAAP results the one thing you're seeing. That said, we still saw declines in our gross margin percentage, primarily driven by what I just talked about at the lower volumes not offset with commensurate declines in spending. Pulling out the PFAS charge we saw our underlying gross margin decline about 100 basis points.

Okay. Thanks for that clarification. Operator Our next question comes from the line of Andrew Kaplowitz of Citi. Please proceed with your question.

Hey, good morning, guys.

Good morning, Andy.

Nick, you mentioned productivity is the issue, a big issue in Industrial in North America and Asia Pacific. If we go back over time, industrial has been a segment where 3M has consistently struggled to grow margin and obviously productivity we talked about was worse in Q1. So could you talk about the transformation helping North America? I know you mentioned it's helping, but it's hard to see. I mean can you talk about your confidence that you can improve productivity in the quarters, especially in North America and Europe where you've talked about an expectation of big margin improvement going forward?

Yes. When examining the Industrial segment, we are concentrating on a few productivity aspects. Firstly, we are aligning our productivity with the growth we observe in the business. The automotive OEM and aftermarket sectors are facing challenges, and we are particularly aggressive in addressing these productivity issues. However, this challenge is broader, especially in the U.S., where we are a net exporter and support business globally, particularly in Asia. Thus, we are experiencing a wider softness in those markets, making it a significant productivity challenge in the U.S. and across the Industrial segment. Our focus is on taking proactive measures to address this and leveraging other initiatives to create greater value, with Business Transformation being a key component. Although we have not yet implemented this in U.S. plants, we've made substantial progress since our go-live last year, with positive benefits and value emerging from our ERP deployment in Canada and EMEA. Our margins, including those in the Industrial segment, have been improving partly due to our Business Transformation efforts. Moving forward, this will be an essential lever, but in the short term, we need to address the effects of slowing end markets and ensure our productivity aligns accordingly.

Okay Mike. And maybe shifting gears. Can you talk about the cadence of your business performance through the quarter and what you've seen to the extent that you can talked about in April. Theoretically, there's been more enthusiasm in places like China given an increase in our tax cuts that could help markets like China auto or electronics. So have you seen any improvements in any of your short cycle businesses over the last few weeks or a month or two?

Yes, Andy, certainly as we went through first quarter we talked a bit about the slowing that we saw as it went through the quarter and that continued right through the end of the quarter. And really, led by those markets, China automotive, electronics. So those are all the ones we've been talking about. There is – I think the outlook is, that gets better. When you listen to the projections and the economic projections in those areas, we haven't seen that. Our April is basically on track with what we're laying out for our total year guidance. But seeing a market improvement in those markets, I think we'll see – we'll get an answer as we move further into the quarter, into the second quarter.

Thanks, guys.

Thank you. Good morning, everybody.

Good morning, John.

Mike, you opened the call talking about you, sort of, were positive – remain positive on a global macro. But I'm trying to understand, maybe, back to Andy's question, there are a degree of evidence, right, that electronics markets in Asia, maybe even China and China auto and so forth, are bottoming. Why you would you take the 2,000 hedge action now? I mean, are you implicitly signaling that you actually don't think that there is going to be much of an improvement in the foreseeable future? Or is this kind of a catch-up from something you should have been doing before and you were just hopeful things were not going to kind of fall apart to the degree they have?

Yes. John, so your point about the global macro is right. There is an expectation that there will be a broader growth in the global macro and maybe a bit slower as we come through the year in terms of global industrial production in particular. In the markets that we're talking about, they certainly have been slowed. But people have a view that it gets better as we get into the second half. I think, to a degree it's realigning ourselves. The actions we're taking are realigning ourselves with what we see in the market and what we've been working through as we come through for sure, kind of, the end of Q4 or end of Q1. If the markets recover, we – this is our playbook. When we see a slowdown, we realign our costs, we realign our operations, we take some targeted restructuring action and then we're in a good position to lead out. So I think this aligns us with what we today, really what we need to do in order to deliver on our commitments and then positions us to lead out of it. And so, if we do see that improvement in the second half, we'll be well positioned to lead out, even with these actions that we're taking.

In other words, you don't have to hire people back if things turn? Is that what you...

No, I think we're aligning ourselves as we go forward, taking advantage of some of the things that we're doing to – with business transformation to leverage that. So this is – it's never easy to do this. And it is – you're asking question around something that we think very hard about. And I really am taking on very personally, we've got to think about what do we need to do near term and position ourselves for the long term. And we're going to continue to invest in growth into R&D and R&D growth programs and priority growth opportunities more broadly. So we're making sure to make this restructuring and realignment targeted to what we have to manage through. And so, will we need to hire people in the future? Yes, of course. As we go forward, we will, where we see the opportunities and we'll invest. But in the near term, we've got to realign ourselves to be ready to deliver on those statements.

I want to shift our focus to PFAS. Based on the K, it seems that litigation over the past few years has been increasing. There are various reasons people have suggested for this. First, can you confirm that you don’t have any insurance to cover these litigation costs? I believe the payment to Minnesota came from cash reserves, correct? Also, can you share what your strategy is for handling this situation? Will you be litigating concurrently, or will you bundle these cases together? It’s difficult to understand why this situation doesn’t resemble the asbestos crisis, which caused many U.S. companies to go bankrupt. While I don't think you are in that predicament, any insights you can provide would be appreciated.

Hey John, I’ll start by discussing insurance, and then I’ll hand it over to Mike for your broader question. Regarding insurance and coverage for environmental claims like PFAS, we believe we have insurance coverage in some areas and are currently in discussions with insurance carriers about these matters. However, it's going to take time to resolve this, so don’t expect immediate developments on that front.

Yes. Regarding the litigation activity, we are actively defending ourselves in all these cases. It's challenging to predict the timing and outcome of any specific litigation. This quarter, we were able to establish reserves that will assist us in resolving the litigation related to environmental issues. I want to clarify that we are directly involved in litigation concerning our manufacturing and disposal practices. As I mentioned earlier, this does not include any other product-related PFAS litigation. In terms of manufacturing, where the outcomes are probable and measurable, the product-related litigation we are currently defending is not at this point considered probable or measurable. We will provide updates as necessary once we have more clarity on these matters. Essentially, there are two distinct aspects that we are managing.

Would it be fair to say this is going on for years. I don't see any milestone event that potentially stops there. Is that a fair thing? It looks like the EPA is going to potentially come out with even more articulate regulations or guidelines or something like that.

Yes, and we continue to work with the EPA and other regulatory bodies on the foundation for the regulations that are being talked about and what will come. EPA, of course, announced a management plan for this and we're working with them to support where we go forward there. We actually are supportive of a federal approach here so we don't end up with a state-by-state approach that's different or patch work kind of approach. But it is something that is evolving and we'll continue to help be part of that with the EPA. And like I said, we'll update you on our litigation matters as appropriate.

Hi, good morning.

Good morning, Julian.

Maybe a first question for Mike. So just trying to think about the last few months at 3M. You had the outlook meeting in November with some medium-term goals. Then you had a sort of re-segmentation more recently, and then today restructuring alongside another guidance reduction. So I understand that the restructuring and the guidance reduction, obviously, very closely linked. But I'm trying to understand what else has changed since that November meeting where it sounded like a case of steady-state high CapEx, high R&D the same segments. Then we heard the segments being changed. Now, the CapEx commitment seems to be wavering per the CapEx cut this morning. So, maybe just talk us through more broadly how your own thoughts about running and organizing and managing 3M have changed in the past few months.

Sure. I will revisit this during the November Investor Day. First of all, the reorganization of the business group was part of our considerations at that time, but we weren't prepared to announce or implement it yet. There were preparations needed for that. However, it is part of our expectations to improve margins by 200 to 300 basis points. This setup aims to help us leverage our business transformation and streamline our connection with customers. It fits into our long-term strategy. As we entered the year and progressed through the quarter, we recognized a slowdown in some key end markets, which intensified as we approached the Q4 earnings call in January. In February, we observed further slowdowns, and we discussed these developments. We took several actions to address the emerging slowdown, but we didn’t act quickly enough. Thus, the restructuring and other measures we are taking are intended to rectify this situation now. I would say this is still aligned with our five-year plan and our commitment to investing in growth and R&D, as well as the strategies we previously outlined. The 3M model is robust, and we need to focus on executing in the short term to align with what we see in the end markets. This has led us to adopt a new set of actions, and we are following through with them. We are confident in executing this approach and will be mobilizing the team as we move forward in the coming days.

That's helpful. And then my second question maybe around any updated thoughts on the portfolio. Should we view the re-segmentation as opening the door to any divestments? Does the guidance reduction make you think that maybe more portfolio pruning is needed? And on the other side of the ledger, should we expect more acquisitions now that M*Modal has closed? Or is it more of a case of there are some internal things to fix, let's fix those first and think about M&A maybe next year?

Julian I'll start here as I always do. Organic growth is our first priority. So, we're going to continue to focus investments there as I said even as we go through this restructuring. But we still maintain flexibility to invest in the long-term value of the enterprise. And so acquisitions we have built strong capabilities to make acquisitions that fit with our fundamental strengths that fit in our most attractive markets. And we've been executing that. We still see that as a value driver for us in the future. And so we continue to stay active looking at acquisitions. We're going to continue to step into compelling acquisitions that leverage that strategy and capabilities that we have to create value. On the divestiture side, we've been actively managing a portfolio since 2012. And over the last three years, we've strengthened parts of our portfolio. It was a case we're always looking at how do we maximize the portfolio. And we're looking at businesses regardless of size on how we do we do that and how do we maximize value for the company and it's really around the fit with our fundamental strengths and we'll continue to actively manage it as we go forward. It's an ongoing process and we'll be focused on creating value with that as well.

Great. Thank you.

Hi. Good morning, guys.

Good morning, Josh.

Just on the comment on inventory destocking, Mike and Nick, do you have a sense for what that might have cost you in the quarter?

Josh, so for the quarter we still built inventory.

I mean, your customer's destocking. I'm sorry.

I'm sorry. I think it very easily could have impacted our total revenue by 100 basis points.

Josh just to give you a little color too. The automotive slowdown in China was one particular case where we saw significant impact in our growth from channel. And so where you see a slowdown in a particular market, like electronics or automotive it's accompanied with a change in inventory, everything from finished goods back through the value chain. And so that is a – that's clearly visible in those cases.

Got it. And then just pivoting back to an earlier question on some of the PFAS litigation, as a non-attorney this is maybe more obvious to other folks than myself. But given that you already have kind of one fight example in Minnesota with an 850 settlement. Is there a reason why adding the other four in there might not just be 850 times four. Is it kind of an easily digestible answer? Or is it a lot of, hey it depends and there's a lot of differences?

Well, our manufacture footprint is different in every one of those sites and so that's part of it. But it really – I guess, if you can take from this is, it's not simply that – not simple math of multiplying times five. We've – we now define probable and estimable for the litigation that we face in those five sites as – with this reserve. So that is our – the way we have had determined what is estimable across that.

Got it. Thanks for that. And then just one last one on some of the re-segmentation. I understand this is not the quite the same thing as ERP was last year. But could we expect some sort of disruption to the customer side with some of the restructuring and re-segmentation being implemented? Thanks.

The realignment of the businesses is really – really the key focus for us was the customer and really aligning to them aligning to the customer segments and the type of customer and the go-to-market model. So we are actually – we've been moving towards this with some of the go-to-market model, capabilities that we've been putting in place and the way we leverage Business Transformation. This actually steps it forward even more. So I think this is not only focused on the customer I think the customers will see this as a positive step forward. And we'll see it as better aligned to them as we globally as we move ahead.

Okay. Thanks Mike.

Thank you. Good morning, everyone.

Hey, Deane.

Hey, I missed the very beginning intro comments. And we've touched on this channel inventory adjustment topic a couple of different times, with Josh's question just then. But can you just clarify how much was any kind of 4Q pull-in getting ahead of tariffs, getting ahead of price increases? And maybe you also had some of this ERP pull-in as well. How much of a factor is that in terms of this inventory adjustment?

Yes, Deane, we discussed this a bit during our Q4 call. We found the channel to be quite balanced as we entered the year. There wasn't a pull-ahead in Q1 from Q4. The ERP impacts were mainly felt in Q2 and Q3, with some residual effects in Q4. It's possible there might be a slight carryover as we start this year, which could relate to some inventory adjustments. From a U.S. perspective, as we progressed through the quarter, the Health Care channels remained well balanced. We definitely observed a good equilibrium among sell-in, sell-out, and consumer. The changes driven by the Electronics and Automotive sectors had the most significant effect on the channel. There were minor issues in Safety and Graphics, particularly in transportation due to project delays, but the major changes occurred in the Industrial and Electronics sectors. This developed as the quarter progressed, leading to a very direct response that we noted in Q1.

Got it. Regarding your comments about the delay in adjusting costs to match the lower demand throughout the quarter, I would be interested to hear what was different about your response time. Is this simply a characteristic of the 3M short cycle business? Perhaps you lack the visibility needed to reduce costs quickly. Does this put you at a disadvantage in terms of responsiveness? When I look at decrementals, companies that can quickly reduce costs usually experience a 25% decremental, and you're significantly lower than that. It seems like the situation got away from you, but additional insight would be helpful.

Yes. Deane we did take actions as we saw slowing growth. We're reducing production plants, we're adjusting demand plans. And we're trying to look ahead as much as we can into our customers to get a clear view. And I would say in the direct businesses, we got a pretty clear view. It was a matter of how fast can we react. And we took actions in the end our volume that we produced went down in line obviously with our organic growth, but our costs didn't. And that was one of the challenges. And some of that is fixed cost, some of that is variable costs and we need to do something on both of those. And so that's where the restructuring is targeting that. And that's not unusual in these situations in the industrial slowdown in 2015-2016; I faced the same thing in leading that business and even in 2009. We have to take restructuring actions to really step into a bigger slowdown and in most particular markets that's what is taking here. And so the steps we took now we'll get ahead of the curve.

Got it. Thank you.

Hi, good morning guys.

Hey Scott.

Hi. I want to change gears a little bit because I think most people at this point kind of get the issues. But I want to talk a little bit about R&D productivity and payback because just back the envelope, I don't think 3M historically has outgrown the Industrial group, in fact, it seemed to have undergrown some of the higher end peers out there and certainly spent a lot of money on R&D. Obviously there's a higher margin structure that is supported by that. But how do you fix that? How do you get the growth rate to really accelerate from these levels, which are really, basically just GDP type levels over time over really almost any time period you look at?

Yes, Scott, you're correct. Our investment in research and development, as well as broader innovation, is essential to fulfilling our commitment to investors for strong growth. This growth should outpace macroeconomic trends throughout our business cycles and yield premium margins and returns on invested capital. Innovation is key to achieving this. In a quarter like this, and given the cycle we're in, it's appropriate to scrutinize our growth prospects. Our focus is clearly on this area. Our capacity to surpass macro growth rates over time is driven by two main factors: our investment in innovation and our ability to create new opportunities for growth with our innovative solutions and priority growth platforms. This is a significant focus for us. Additionally, it's crucial that we target markets that enhance the macro environment we are operating in. We often discuss our priorities for organic growth in capital allocation, aiming for approximately 6% of sales and research and development, and between 4% to 5.5% in capital expenditures. We prioritize these aspects because achieving growth in key markets is critical. This is what I mean when I refer to our ongoing commitment to investing in growth.

Fair enough Mike. And when every add, I mean, you've been on board now you're not brand-new, but you're relatively new I think in comparison to many CEOs. And do you think you need to change the compensation scheme at all? Or is there something that as far as getting incentives more aligned with faster execution, because and I don't mean this to be mean. But if you go back really think about the 20 years or so I've covered your stock. 3M always seems to be a little bit behind on the restructuring curve almost never ahead. And even if you get this one right you're still behind. So do you need to change anything around the incentives or compensation scheme to get some of your leaders to move a little faster?

Compensation plays a significant role in this matter. We have made updates and adjustments to our compensation over time to align our leaders with our objectives. This alignment specifically ties to our commitments to investors, including organic growth, EPS growth, ROIC, and free cash flow. Our leaders are focused on these four commitments. If we should reassess this approach, I would say it’s typical for us. We will evaluate our activities and strategies, and compensation will be a key component of that review.

Good morning. I wanted to address two things. First, as you consider the situation, when I reflect on the call, you mentioned this type of sequencing typically spans multiple quarters. I recall how you analyzed it a few years back. Could you clarify if you've noticed any real changes in your order patterns, or are these just effects of stabilization over time?

Lawrence, I mean you broke up a bit, so I'm not sure I got a question. But I think you're asking about the softening and the slowdowns that we're seeing. They can sometimes last longer. Do we see any indication that those are turning or not expected last long, is that the kind of…

Right. Have you noticed any actual changes in order patterns, or is it simply that everyone is anticipating the second half?

We haven't observed a significant change in the softening markets. As we approach April, our expectations remain consistent. It seems like the inventory adjustments are beginning to slow down, which typically doesn't happen in the fourth quarter unless there's another macro event influencing it. These adjustments usually occur fairly quickly, and we might be catching some early signs of that. However, in sectors like automotive electronics, where forecasts indicate a stronger second half, we haven't seen early signs of that yet. While their outlook makes some sense, we haven't observed any concrete shifts as of early April.

And by the way… The New Jersey is not one of the places where we manufacture. That's a different lawsuit related to the use of the product and not related to our five manufacturing sites Nigel.

Hey, good morning.

Good morning, Steve.

When I review the annual bridge on EPS, I believe you were expecting about $0.30 to $0.40 from transformation productivity and pension tailwind this year. Are these still isolated items? Are they still on track?

Yes. Steve, the pension impact, the underlying business transformation productivity, the footprint action savings, those are all on track. But with the lower growth, the two things changing, lower growth and all other productivity, those are the two components that are bringing that that part down, as well as the charge that we're anticipating in Q2 for the restructuring actions.

Okay. Yes. And that entire charge is coming in Q2. You're going to take that or run that through EPS?

We think the majority of that – it could be all of it, but we think the majority of that will be in there.

Okay. Can you just give us a little bit of color on what you kind of expect now for margins? Whether it's second quarter, the year, I mean, the more detail the better it is, so we call all kind of calibrate and reset ourselves from this level, operating margins.

Yes. Steve, when we take into account our recent acquisition of M*Modal, when we take into account this restructuring charge, we are seeing margins down likely 100 basis points for the year, with those two items contributing just over half of that total decline in the margins. And that's different, where, from a three months ago, saying we were expecting margins to be up. The core underlying productivity, even with these actions we don't think it's going to be accretive to our margins yet this year. We think that will come later.

Right. And one last quick one. So you mentioned Minnesota on the PFAS stuff. I thought you guys already took a charge for Minnesota. Was that – are you saying, we already took that charge, so we're just reminding you of it? Or was there an incremental charge in Minnesota?

Yes, Steve, it was a bit of a reminder. Just to let you know, this encompasses those facilities. There was a small part of it that is part of Minnesota as we look ahead. The $850 million was the majority, the vast majority of what we faced in Minnesota.

Yes. That charge of $850 million is from last year, Steve.

Yes. No, no. I was just – I'm trying to, kind of, like, I just – I don't know whether the – I thought the $850 million kind of ring-fenced it, for a lack of a better term. So the fact that there's kind of another charge in Minnesota, I'm just trying to kind of – I definitely haven't done – I'm not a lawyer, I don't know how to work on this. So I thought kind of the $850 million took care of Minnesota.

Yes. And that's the way to think about it, Steve. We…

Okay.

This was just to make it complete, so that we didn't leave Minnesota out and then have it kind of questioned by exception.

Yes. Okay, great. Thanks a lot, guys. Thanks for detail.

Hi. Thanks. Good morning, guys.

Good morning, Nigel.

Yes. I just want to pick up on Steve's point there. What was the trigger point to make this NRD charge probable and net submitable? I know there was a ruling in New Jersey. Was that the sole trigger point? Or was there something else that we're missing?

With the NRD I think really what you're talking about Nigel is a year ago. I think what you're really asking is, what's the triggering point for us to be taking this charge now in the first quarter. And we've been working on that with a number of the parties, where we have litigation going on. And we reached a point where we felt that based on the progression of those, the facts on those cases and where we stood with potential settlements, we actually did have some settlements occur in the first quarter, which gave us better visibility in how to estimate more broadly across all our manufacturing sites, what we see is our liability.

Okay. Thank you. To wrap up, we are moving with urgency and taking action to strengthen our performance in 2019, while investing for the future. I remain confident in the world-class capabilities of our enterprise and in our 3M model. We know we have to rebuild our credibility. I'm confident we will get our performance back in line with the expectations of our investors. Thank you for joining us.