3M Company (MMM) — Q4 2022 Earnings Call Transcript

Thank you, and good morning, everyone, and welcome to our Fourth Quarter Earnings Conference Call. With me today are Mike Roman, 3M's Chairman and Chief Executive Officer; and Monish Patolawala, our Chief Financial and Transformation Officer. Mike and Monish will make some formal comments, then we'll take your questions. Please note that today's earnings release and slide presentation accompanying this call are posted on the home page of our Investor Relations website at 3m.com. Please turn to slide 2. Please take a moment to read the forward-looking statement. During today's conference call, we'll be making certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions. Please turn to slide 3. Please note throughout today's presentation, we'll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments to today's press release. Before I hand the call over to Mike, I would like to take a moment to highlight a financial reporting change we are making starting here in Q1 2023. As we announced in our press release on December 20th, we'll be exiting PFAS manufacturing by the end of 2025. As a result, we have decided to provide additional disclosure by expanding the scope of our non-GAAP measurement adjustments to include the exit of PFAS manufacturing. For 2022, we have treated the Q4 PFAS manufacturing exit cost as a special item in arriving at results adjusted for special items. However, beginning in 2023, we will expand the existing adjustment for special items to also adjust for the sales and estimate of income and associated activity of PFAS manufacturing. Therefore, our outlook for 2023 reflects this adjustment. Today's press release, press release attachments, and slide presentation provide information regarding our 2022 performance on our existing Q4 2022 non-GAAP basis, along with some comparative information on the new 2023 outlook basis. We will be providing a Form 8-K during the first quarter to reflect additional effects of this change in our non-GAAP measures and changes in segment reporting. We remain committed to providing strong transparency in reporting our financial performance. And of course, we are always here to address your questions. With that, please turn to slide four and I'll now hand the call off to Mike.

Thank you, Bruce. Good morning, everyone, and thank you for joining us. We continue to focus on delivering for our customers and shareholders in a challenging economic environment with slowing growth, inflation, and supply chain disruptions. We posted organic growth of 0.4% versus our expectation of 1% to 3%, along with adjusted margins of 19% and adjusted earnings of $2.28 per share. The slower-than-expected growth was due to rapid declines in consumer-facing markets, such as consumer electronics and retail, a dynamic that accelerated in December, as consumers sharply cut discretionary spending and retailers adjusted inventory levels. We also saw a significant slowing in China due to COVID-related disruptions, along with moderating demand across industrial markets. As demand weakened, we took actions to adjust manufacturing output and control costs, which enabled us to deliver a $250 million inventory improvement. In addition to the actions taken in the second half of last year, today, we announced restructuring in our manufacturing operations, as we expect the demand trends that we saw in December to extend through the first half of 2023. I will discuss this more later in the call. With supply chain stabilizing, we are focused on improving manufacturing operations and driving working capital. These are our most significant opportunities to improve margins and cash flow. As we navigate the external environment, we continue to position 3M for the future by investing in growth, productivity, and sustainability. I will recap 2022 and our outlook for 2023 after Monish takes you through the quarter.

Thank you, Mike, and I wish you all a very good morning. Please turn to slide five. As you will recall, we highlighted negative trends in our consumer retail and electronics-related businesses in late November. As the fourth quarter progressed, those trends accelerated. We also experienced significant slowing in China as COVID-related impacts resulted in a 17% decline in organic sales in December and down 8% for the quarter. Health Care continued to be challenged in its recovery to pre-pandemic levels, given labor shortages and hospital budgets being under pressure, while industrial end markets mostly remain steady. Fourth-quarter total sales were $8.1 billion or down 6.2% year-on-year, which included headwinds from foreign currency translation of minus 5% or $400 million, which is better than the minus 7% we had expected. We also experienced a 1.6% decline from divestitures, or nearly $140 million, largely from the third quarter divestiture of food safety, along with the deconsolidation of Aearo Technologies. On an organic basis, fourth-quarter sales increased 0.4% versus last year. This result included an anticipated falloff in disposable respirator demand and the exit of our operations in Russia. These two items, combined, negatively impacted organic sales growth by approximately $230 million or 2.6 percentage points. Excluding this decline, Q4 organic sales growth was 3%. On an adjusted basis, fourth-quarter operating income was $1.5 billion, with operating margins of 19.1%. Adjusted earnings for the quarter were $2.28 versus $2.45 last year. Turning to the components that impacted fourth-quarter operating margins and earnings year-on-year performance. We took a number of actions to navigate the fluid and slowing macroeconomic environment, including managing selling prices to address inflationary pressures, reducing manufacturing output, maintaining strong spending discipline and taking additional restructuring actions to streamline the organization and adjust to slowing end market demand. These actions delivered an underlying benefit to operating margins of 110 basis points and $0.19 to earnings. This helped more than offset headwinds from the sales decline in disposable respirators and the Russia exit, which negatively impacted operating margins by 70 basis points and earnings by $0.15 per share. Inflation continues to impact raw material, logistics, and energy costs. These pressures remain persistent and are broad-based. In Q4, raw material cost increased approximately $110 million or a negative impact of 1.4 percentage points to operating margins and $0.16 to earnings. As mentioned, foreign currency translation was a negative 5% impact to total sales. This resulted in a headwind of $0.10 to earnings per share, however, it was a benefit of 10 basis points to margins. Divestitures primarily related to Food Safety, along with the deconsolidation of Aearo Technologies, resulted in a year-over-year headwind of $0.04 to earnings per share in the quarter. Finally, other financial items increased earnings by a net $0.09 per share year-on-year driven by lower share count, partially offset by a higher tax rate. Please turn to Slide 6. Fourth-quarter adjusted free cash flow was $1.7 billion, up 3% year-on-year, with conversion of 131%, up 18 percentage points versus last year's Q4. During the quarter, we aggressively adjusted manufacturing production levels to end market trends, which drove a sequential reduction in inventory levels by $250 million. For the full year, adjusted free cash flow was $4.7 billion with adjusted free cash flow conversion of 82%. Capital expenditures were $506 million in the quarter and $1.75 billion for the year, or up 9% year-on-year as we continue to invest in growth, productivity, and sustainability. Looking to 2023, we expect capital expenditures in the range of $1.5 billion to $1.8 billion, which includes approximately $200 million of investment in water stewardship related to our exit of PFAS manufacturing. During the quarter, we returned $1.4 billion to shareholders through the combination of cash dividends of $820 million and share repurchases of $540 million. For the year, we returned $4.8 billion to shareholders, including $3.4 billion in dividends and $1.5 billion in share repurchases. In addition, we reduced our outstanding share count by 16 million shares via an exchange offer associated with the Food Safety divestiture. Having a strong balance sheet and capital structure remains a priority for 3M, because of the flexibility it provides. Net debt at the end of Q4 stood at $12 billion, down 4% year-on-year with net debt-to-EBITDA at 1.4 times. Please turn to slide 8 for our business group performance. I will start with our Safety and Industrial business, which posted sales of $2.7 billion or up 1.3% organically. This result included a year-on-year headwind of approximately $165 million due to the ongoing decline in demand for disposable respirators. Excluding disposable respirators, Safety and Industrial grew Q4 organic sales by 7.5%. Our Personal Safety business declined mid-single digits organically, primarily due to the decline in disposable respirator demand. Turning to the rest of Safety and Industrial. Organic growth was led by low double-digit increases in electrical markets, automotive aftermarket, and abrasives. Industrial adhesives and tapes and closure and masking systems both declined low single digits. Operationally, the Safety and Industrial team drove strong execution during the fourth quarter. Adjusted operating income was $611 million, or up 9% versus last year. Adjusted operating margins were 22.4%, up 2.7 percentage points as the team managed inflation with price actions, drove yield and efficiency, and exercised strong spending discipline, while also investing in the business. Moving to Transportation and Electronics, which posted sales of $2.1 billion, or up 1.4% organically. Our auto OEM business increased mid-teens versus a 2% increase in global car and light truck builds. We continue to gain penetration on new automotive platforms while also benefiting from a favorable comparison due to last year's Q4 channel inventory drawdown. Our electronics business declined 10% organically as it continued to be impacted by the significant end market weakness particularly for smartphones, tablets, and TVs. Turning to the rest of Transportation and Electronics. Advanced materials grew organically low double digits, while both commercial solutions and transportation safety increased low single digits. Transportation and Electronics delivered $366 million in adjusted operating income, down 3% year-on-year. Adjusted operating margins were 17.8%, up 60 basis points versus Q4 last year. The team was able to more than offset manufacturing productivity headwinds and inflationary pressures with ongoing benefits from pricing, along with strong spending discipline and restructuring actions while investing in the business. Looking at our Healthcare business, Q4 sales were $2 billion, with organic growth of 1.9% versus last year. Sales in our medical solutions business declined low single digits organically. Fourth-quarter elective health care procedure volumes were approximately 90% of pre-COVID levels as nurse labor shortages and strained hospital budgets continue to impact the pace of recovery. Oral care was up low single digits despite decreased consumer spending on discretionary items. And finally, separation and purification organic sales increased high single digits while Health Information Systems was up mid-single digits. Health Care's fourth-quarter operating income was $421 million, down 18% year-on-year. Operating margins were 20.6%, down 2.9 percentage points, with adjusted EBITDA margins of nearly 29%. Year-on-year operating margins were impacted by manufacturing productivity headwinds, increased raw materials and logistics costs, along with investments in the business. These headwinds were partially offset by pricing actions along with the strong spending discipline. Lastly, our consumer business posted fourth-quarter sales of $1.2 billion. Organic sales declined 5.7% year-on-year with particular weakness in the US, which was down high single digits. All businesses declined organically as consumers pulled back on discretionary spending and retailers aggressively took actions to reduce their inventories, particularly in the US. Looking ahead, we anticipate those trends to continue at least through the first half of 2023. Consumer's fourth-quarter operating income was $224 million, down 24% compared to last year, with operating margins of 17.9%, down 3.3 percentage points year-on-year. This year-on-year decline in operating margins was driven by increased end market weakness, higher raw materials and logistics, and outsourced hard goods manufacturing costs, manufacturing productivity headwinds, along with investments in the business. These headwinds were partially offset by selling price actions and strong spending discipline. I'll now turn it back over to Mike for a recap of our full-year 2022 performance.

Thank you, Monish. 2022 was a pivotal year for 3M. Throughout the year, we took decisive actions that are foundational to our future and at the same time, maintained our focus on our customers. We addressed inflation through selling price actions and proactively managed cost as demand softened throughout the year. To address supply chain disruptions, we did what was necessary to serve customers and reduce cycle times, including opening a new distribution center on the East Coast. We navigated COVID-related lockdowns in China. We reached an agreement with the Flemish government to restart operations in Zwijndrecht and exited our Russia business. As always, we put 3M science to work to solve customer needs across our market-leading businesses. In Safety and Industrial, our new robotic paint repair system received multiple prestigious honors, as we continue to drive innovation in automotive manufacturing, an area we led in for more than 100 years. In Consumer, we launched Scotch cushion lock, a sustainable alternative to plastic wrap, which was recognized by Fast Company as one of its world-changing ideas. In Health Care, we advanced our leadership in wound care, which includes our negative pressure wound therapies, becoming the first solution of its kind to surpass 2,000 peer-reviewed studies. In Transportation and Electronics, we introduced new thermal barrier films to improve performance of electric car batteries, one element of our $0.5 billion automotive electrification platform, which delivered 30% organic growth in 2022. Company-wide, for the total year, we delivered organic growth of 1%, or 3% excluding the impact of disposable respirators and our Russia exit. We posted adjusted EPS of $10.10, along with adjusted free cash flow of $4.7 billion with an adjusted conversion rate of 82%. We strengthened our balance sheet and reduced net debt by $0.5 billion, ending 2022 with a net debt-to-EBITDA ratio of 1.4. This enabled us to invest in the business and returned $4.8 billion to shareholders through dividends and share repurchases. At the same time, we took actions to position us for the long-term. We divested our Food Safety business, receiving $1 billion and reducing our outstanding share count by 16 million. We continue to progress in our healthcare spin-off, which will create two world-class public companies better positioned to drive growth and value creation. With respect to combat arms litigation, as last week's report from the Chapter 11 co-mediators indicated, 3M continues to support Aearo Technologies in this ongoing confidential mediation process. We continue to address PFAS litigation by defending ourselves in court or negotiating resolutions as appropriate. We also announced we will exit all PFAS manufacturing by the end of 2025. Our decision is based on careful consideration of the external landscape, including regulatory trends and changing stakeholder expectations. We simplified and streamlined our supply chain organization and advanced our digital strategies to better serve customers. We followed through on our sustainability commitments. We are ahead of schedule installing state-of-the-art filtration technologies and factories around the world. We now have capabilities up and running at all three of our largest water using sites in the US. We supported employee health, safety, and well-being, including new flexible work arrangements and factory investments and we advanced diversity, equity, and inclusion, with each of our business groups now executing initiatives. The steps we took in 2022 and the steps we are continuing to take in 2023, position us well as we look toward the future. Please turn to Slide 11. We expect market and macroeconomic challenges to persist in 2023. Based on this outlook, we expect organic growth of minus 3% to flat, along with adjusted EPS of $8.50 to $9, and adjusted free cash flow conversion of 90% to 100%. Our expectations reflect the slowing in demand we are seeing as we start 2023. Supply chains are improving. However, we still see headwinds from material availability and inflation, albeit at a lower level. We are not satisfied with our progress or performance. We are taking additional actions, building on the actions taken in the second half of 2022 to reduce cost structure and inventory. We have implemented strict control of hiring and discretionary spending. Today, we announced that we will reduce approximately 2,500 global manufacturing roles, a necessary decision to further align with adjusted production volumes. In addition to the actions we are taking to respond to the macroeconomic environment, we are taking a deeper look at everything we do as we prepare for the Healthcare spin. As we move through the year, we will take additional actions to improve supply chain performance, drive simplification and bring us even closer to our customers. At the same time, we win in the market because we stay close to customers and continue to invest in innovation even in the most difficult times. We will continue to invest in growth opportunities in our businesses, aligned to global trends that take best advantage of our innovation. Automotive electrification, industrial automation, biopharma processing, and home improvement are just a few examples of large, fast-growing markets where we are investing and where 3M innovation can make a difference. We will continue to prepare for the spin-off of our Health Care business, which presents a tremendous value creation opportunity while at the same time, preparing 3M for future success. We will work to resolve litigation we face following through on the actions we initiated in 2022. Underpinning all of our work will be the strengths of 3M, our people, our industry-leading innovation, our advanced manufacturing, our global capabilities, and our iconic brands. I am confident in our future; as we exit 2023, we will be a stronger, leaner, and more focused 3M. Monish will now cover the details of our outlook.

Thank you, Mike. Please turn to slide 12. The macroeconomic environment remains very fluid and uncertain. For 2023, we anticipate that GDP and IPI will continue to moderate with both currently estimated to be around 1.5% or about half of 2022 levels. Therefore, against this backdrop, we feel it prudent to set our expectations to reflect this reality. As Mike mentioned, we estimate our full-year adjusted organic sales growth to be in the range of minus 3% to flat. This includes selling prices up low single digits. Therefore, organic volumes are expected to be down low to mid-single digits for the year. This range also includes an estimated two percentage point headwind from the ongoing decline in disposable respirator demand, along with the impact of our exit from Russia. We currently expect our disposable respirator demand to be down to pre-pandemic levels. As the strength of the US dollar carries into 2023, we estimate a foreign currency translation impact to sales of minus 1% to minus 2%. And divestitures that were completed in 2022 will be a headwind to sales of nearly one percentage point. Adjusted earnings are expected to be in the range of $8.50 to $9 per share. This range includes a combined earnings headwind of $0.55 to $0.80 per share year-on-year from the following three items. First, the expected sales decline of disposable respirators and exit of Russia will be an impact of minus $0.30 to $0.45. Second, foreign currency will be a headwind of minus $0.10 to $0.20; and third, divestiture impacts would be a minus $0.15. In addition, the 2022 carryover impact of higher raw material and logistics costs, combined with energy inflation, creates a year-on-year headwind of approximately $150 million to $250 million or roughly $0.20 to $0.35 to EPS. And finally, non-operating items are estimated to be an impact to earnings per share of flat to minus $0.10. This range includes a year-on-year increase in non-operating pension expense of $125 million. A full-year adjusted tax rate in the range of 18% to 19% and a lower year-on-year outstanding share count. While there are a number of headwinds to earnings in 2023, ultimately, our full-year performance will be driven by organic sales volumes, sustained progress in global supply chains and raw material availability, and our ability to drive improvements and reduce costs in our manufacturing and supply chain operations. Finally, full-year adjusted free cash flow conversion is forecasted to be in the range of 90% to 100%. This range includes the continued healing of global supply chain, expected improvements in working capital performance, particularly inventory reductions and full-year capital expenditures of $1.5 billion to $1.8 billion, which includes approximately $200 million of investment in water stewardship related to our exit of PFAS manufacturing. Please turn to slide 13. Looking at our expected performance by business, we see Safety and Industrial organic sales growth to be down low single digits in 2023. This includes an estimated decline in disposable respirator sales of $450 million to $550 million or a negative impact of approximately four percentage points as the business returns to pre-pandemic levels. Demand across industrial end markets is moderating as customers remain cautious. Our Safety and Industrial team will also be monitoring the recovery of industrial production activity in China as we start the year. Adjusted organic sales growth for Transportation and Electronics, excluding the impact of the exit of PFAS manufacturing is forecasted to be down mid-single digits to flat organically. Looking across end markets, automotive unit volume production is currently forecasted to be up nearly 4% year-on-year. We also expect automotive electrification trends to remain strong as we leverage our technologies and develop new innovative solutions for our automotive OEM customers. Electronics, however, is expected to be down significantly due to weak end market demand for TVs, tablets, and smartphones, along with the ongoing impact of display technology shifting to OLED from LCD. Healthcare's organic sales growth is anticipated to be up low to mid-single digits versus 2022. We expect gradual improvement in healthcare elective procedure volume as nurse labor shortages and strained hospital budgets continue to impact global healthcare systems. In oral care, we will be monitoring consumer discretionary spending and its impact on patient visits, including orthodontic care. The Healthcare team continues to create differentiated value and deliver strong margins for the attractive end markets we serve. And finally, organic sales in consumer are estimated to be down low single digits to flat as US consumers remain cautious and retailers continue to aggressively reduce the excess inventory levels. Despite these near-term challenges, the consumer team remains focused on leveraging our iconic brands and accelerating new products in 2023. Please turn to slide 14. Before we go to Q&A, I want to walk through how we are seeing the first quarter. First, three weeks into January, we are seeing continued slowing in organic sales volume as we start the year. This slow start is driven by the same weakening end market trends that impacted the finish to 2022. We expect soft consumer discretionary spending, along with retailer destocking to continue into the first quarter. Sales of electronic devices are forecasted to be down between 10% and 30% sequentially in the first quarter, while semiconductor end markets and automotive builds are down mid-single digits sequentially. Health care and oral care elective procedure volumes are expected to be at the same levels as Q4. And as we have noted, industrial end markets are mixed. We anticipate the ongoing COVID-related challenges to continue in China and the geopolitical situation in EMEA to persist. Therefore, taking all of these items into consideration, we estimate Q1 total adjusted sales in the range of $7.2 billion to $7.6 billion versus $8.5 billion adjusted for the exit of PFAS manufacturing, or down 10% to 15% year-on-year. This anticipated year-on-year decline includes headwinds of 3 to 4 percentage points from disposable respirator sales declines and the Russia exit, 3 to 4 percentage points from foreign currency translation, and a 1 percentage point impact from divestitures. Taking these factors into account, we expect Q1 organic sales to be down low single digits to mid-single digits. From an EPS perspective, we estimate that first quarter adjusted earnings per share will be in the range of $1.25 to $1.65. This range is impacted by the continued slowing of organic sales volumes, a pre-tax restructuring charge of $75 million to $100 million or $0.10 to $0.15 per share, a tax rate of approximately 19%, along with normal Q1 items. As you can see, the first quarter presents a tough start to the year. We will have our most challenging year-on-year comps related to the declining disposable respirator demand and our exit of Russia. Ultimately, organic volume trends will be the biggest factor in determining how the quarter will turn out. 2023 is an important year as we work on progressing our strategies, including preparing for the spin-off health care, improving our manufacturing and supply chain operations, and taking actions to further streamline the organization. We are focused on creating the shortest path to the customer and providing innovative solutions to their most challenging problems. We will remain nimble and take appropriate actions as we respond to changing market dynamics. And we will continue to invest in growth, productivity, and sustainability to ensure the long-term success of our enterprise. To wrap up, I continue to be bullish on our long-term trends. The large and attractive end markets we serve provide exciting opportunities for the future of 3M. We are not satisfied with our performance and the expected start this year. We are working to aggressively address our operating performance in this challenging environment. We expect organic sales volumes will improve as consumer retail and consumer electronic markets stabilize. China works through its COVID-related challenges and as our year-on-year comps ease. We also expect supply chains to continue to heal and raw materials and logistic cost headwinds to abate. Therefore, we anticipate improvements in organic growth, operating margins, earnings, and cash flow as we progress through the year. As you've heard me say before, there is always more we can do and we will do to improve our performance. I want to thank our customers and suppliers for their partnerships and the 3M employees for their hard work and dedication as they continue delivering for our customers. That concludes my remarks. We will now take your questions.

Hi, good morning everybody.

Good morning, Scott.

Good morning, Scott.

I was hoping you could walk us through, just perhaps logistically or opportunistically, how you exit PFAS. It's so integrated with your product line, your manufacturing systems. Can you sell some facilities? Can you extract some value, or do you just have to close and lock up the facility and walk away? And how does that work logistically?

Yeah, Scott. So maybe I'll take you back to the announcement of the exit. We said we'll exit all PFAS manufacturing by the end of 2025. We also said we would work to discontinue the use of PFAS in our products broadly across the company. That's both in our products, but also in the manufacturing of our products. And I think your question is really on our manufacturing part of that. And we said we will meet contractual commitments that we have to our customers, and we're working closely with them to manage that as we make this transition. But ultimately, I also talked about that we are not planning and won't sell the businesses and that we will plan to shut them down as we work through the transition as we get to the end of that, end of 2025.

Scott, just a reminder, as we disclosed, the exit cost will be in the range of $1.3 billion to $2.3 billion. We took a fourth-quarter charge of $800 million, which is included in that range.

Okay, that's helpful. Could you elaborate on the scope or scale of the restructuring? I believe you mentioned 2,500 people. Are there additional rooftops and significant cost reductions anticipated in this plan?

The announcement we made today involves 2,500 jobs in manufacturing, which is a response to the volume we are seeing and our outlook for that volume. We are focusing on our supply chain and see an opportunity to continue to streamline it. We hope to benefit from some of the improvement as discussed by Monish. We are taking our own actions and exploring further measures we can implement. Additionally, we are examining the overall company as we prepare for the healthcare spin, including looking into 3M ParentCo. Our goal is to simplify, streamline, and position ourselves closer to our customers. This entails a deeper and broader analysis, as we proactively take actions based on our market outlook.

All right. Thank you. I’ll pass it on guys. Appreciate it.

Yeah. See you, Scott.

Hey, good morning, everyone.

Hey, Andy.

Good morning, Andy.

Mike or Monish, you mentioned that industrial end markets are moderating, customers are cautious. I think, for instance, you mentioned industrial adhesives and tapes down in Q4. Has there been a material change from conversations that you've had previously with industrial customers, or is this just gradual moderation? And then is the regional weakness that you're seeing in China just a function of COVID interruption and more consumer base versus end demand related? And how do you think that pans out in 2023?

Yeah. Andy, back to Monish's comments, we're seeing kind of mixed performance in the industrial markets. We see strengths as we said, as we came through the quarter in areas like electrical markets and automotive aftermarket. We were seeing some moderation in specific end market segments. And the comment about industrial adhesives and tapes and closure and masking is some of that is related to the electronics slowdown. So that's part of that impact. It's also impacted by China. So China has really got a couple of things that are part of the slowdown. One of them is COVID and the interruption in the markets in industrial production and GDP. It's also reflecting the importance of electronics to that market into our business there in China. And we see that continuing; those dynamics that we saw in Q4 continuing into the start of the New Year. We saw some moderation in specific segments of industrial. We saw specialty vehicle construction markets. We saw some moderation coming through the end of the quarter. We're off to a slow start as we start the year. There's a couple of areas of destocking really related to those end market segments where we've seen nothing more broad-based than that. We had strong performance across some of those other end markets in industrial. But we are starting to see some moderating and, like I said, January is off to a slower start for industrial.

Mike, that's helpful. And then maybe could you give us a little more color regarding price versus cost expectations for 2023. You mentioned the low single-digit price improvement you're seeing. You also mentioned supply chains are healing. Are you generally seeing pricing hold up for you despite some of this demand weakness across the portfolio? And then versus raw material and energy-related headwinds, does that price versus cost equation getting increasingly green as you go throughout the year?

I see two main points here. As you noted, the carryover impact we've incorporated into our guidance consists of two components related to selling prices. We expect an increase of about 2%. Concurrently, the carryover effect of raw material and energy inflation is estimated to be between $150 million and $250 million. When we combine these factors, the current outlook is positive. As we move forward, we will be evaluating how supply chains stabilize and how quickly we can reduce costs. However, it will take some time as we work through our higher-cost inventory, which may lead to a moderation in results, but we expect improvements throughout the year. A key consideration for us is the potential impact of deflation in the economy, particularly regarding how price elasticity may affect not only our company but others as well. Historically, our innovation has driven the value we provide to customers, allowing us to maintain a favorable price-cost relationship. Therefore, how 2023 unfolds will depend on supply chain developments, but we are confident that our price-cost equation will remain strong due to the value we deliver to our customers.

Appreciate the color, Monish.

Yes. Good morning.

Hi, Andrew.

I have a couple of questions. Are you including an explicit recession in your forecast? What are your macroeconomic assumptions? I understand you mentioned a slowdown, but are you specifically forecasting a recession?

Yes, Andrew. Our outlook for the year is influenced by macroeconomic projections. We're observing specific markets and trends as we move through the fourth quarter and into the New Year. In terms of the global macro environment, we anticipate GDP and industrial production index growth to be around 1.5% for the year, though the US appears weaker, with GDP likely falling below 1% and industrial production potentially turning negative by mid-year. These are the macro factors we're monitoring. Additionally, as noted, there was a 10% to 30% decline in consumer electronics builds in the fourth quarter, which is expected to continue into the first quarter and the first half of the year. Consumer discretionary spending decreased in Q4, and I anticipate that trend will persist. Therefore, the macroeconomic environment is a significant factor, and we are closely examining these key market segments and their indicators. It seems that Q1 may mirror Q4, with some further areas of slowing. We are also considering the overall macro landscape as we refine our outlook for the remainder of the year.

Got you. Regarding pricing, I understand that the way you report it differs from our internal perspective. I appreciate that. Has there been any change in market structure that affects your pricing capabilities? I would have anticipated that 3M's reported pricing would provide more of a boost for 2023. It is what it is, but are you noticing any structural changes that you're working to address? Thank you.

Andy, our pricing actions in the near term consist of two components. One is our continuous evaluation of price value in the marketplace, as Monish emphasized. Our innovations provide value to customers, and we manage our pricing to capitalize on that value, ensuring that it aligns with our overall market pricing. The past couple of years have introduced inflation dynamics, which have significantly influenced our decisions. We are implementing pricing actions to accommodate rising input costs. Therefore, we have a combination of our innovative offerings and the impact of inflation. Looking ahead to 2023, we are confident in our ability to maintain a strong price value through our innovations. We will also be addressing inflation along with others in the market, monitoring its progression and adjusting our pricing as needed based on any further inflation and the market's elasticity regarding it.

Hi, good morning.

Hey, Steve.

Good morning, Steve.

What are you guys seeing on the inventory side of your more industrial businesses? I think you talked a bit about auto, but maybe just on the general industrial side, customer inventory behavior?

Yes. Steve, I touched on a little bit of that. I would say as we began Q4, overall inventory looked to be in pretty good shape. And that was with the notable exception of Consumer. Everyone was working to reduce the inventory, and we saw a lot of destocking efforts in consumer. As I said, we're starting to see some destocking in industrial. I would say, Asia and China, where we are seeing weaknesses in consumer electronics, driving some of that. And as I mentioned earlier, some specialty markets like construction and a few other areas like even packaging, we're seeing some reduction of inventory as we start the New Year. When you look at our transportation and electronics business, the consumer electronics OEMs are reducing inventories. With that outlook for their demand, they're reacting to it. Automotive OEM inventory still remains low. It's improving, but it remains low as they're recovering from some of the supply chain disruptions. Health care, overall, looks pretty stable. We see oral care channels reacting to some of the consumer discretionary spending and slowing there in oral care that we saw really in the second half. And then it comes back, the biggest move is in the consumer where our retailers are still aggressively reducing inventory. So some dynamics reflecting some of the changes in demand in the end markets.

Can you provide some context about January being slow? Is January performing below the low end of the annual range? Just a general idea of how slow it started for you?

Yes, Steve. So back to January; yes, it is lower than the overall range. And partly, that's also driven by the toughest comps that we're going to have going into 1Q. As I mentioned, $7.2 billion to $7.6 billion is the revenue range. It will be down 10% to 15% versus last year's adjusted. And you have to take revenue and adjust for the exit of PFAS manufacturing, which would be around $8.5 billion. But embedded in that is 3% to 4% from foreign currency headwinds. So it's a Q4 carryover impact. You've got 1% from divestitures, which is based on the closure of the Food Safety and some of the other transactions we did in 3Q. And then you've got a very large headwind from DR and Russia. If you recall last year, we had a very strong 1Q with the Omicron variant. Plus at that time, we had not announced the exit of Russia until mid-March. So that's another 300 to 400 basis points of pressure because you've got a comp. And therefore, overall, it's low single digits to mid-single digits is what we think right now is organic sales growth for 1Q. And what you'll find is as the year goes on, these comps start getting easier, and that will start showing the growth on a year-over-year basis. Hopefully that answers your question?

Yes. You weren't down double-digit in January. Are you?

As of right now, we are somewhere in that range of where I told you.

Thanks and good morning, everybody.

Morning Joe.

Morning Joe.

I know we've talked a lot about the organic growth guidance for the year. I guess I'm just curious, when you think about the consumer specifically, it seems like you're embedding improvement as the year goes along. Is that just a function of inventories getting better? How much of that is China reopening? I just want to get an understanding of that business specifically.

Yes, you're right, Joe. I'll begin with a summary. We expect that as conditions stabilize and customers reduce their destocking, the comparisons will improve over the year. The fourth quarter was particularly challenging, and as Mike mentioned, we observed a trend acceleration in December. We are continuing to see that into January, which is why the first quarter starts off quite soft. However, we hope that as conditions stabilize, destocking improves, and consumer confidence increases throughout the year, we will begin to see improvement in our consumer business.

Got it. That's helpful, Monish. And maybe my follow-up question is a little bit of a longer-term question on the electronics business. So, specifically, I think in your comments, as you mentioned that the shift into OLED. I know there was an announcement about Apple making your own custom displays starting in 2024. Just trying to understand how that will potentially impact your business beyond this year? And then is it already expected to impact your business in 2023?

What I would say is that the company has been focused on the LCD-OLED transition for some time now. This shift has been occurring for a few years, and our team has been actively managing it. They are currently assessing the implications of the new devices on the OLED to LCD ratio mix, which certainly impacted us in 2022. We have also anticipated the trends we observed for 2023. However, it's important to note that the Electronics segment, particularly the display team, consistently drives innovation that helps counteract some of these challenges. This business continually adapts over time. For instance, Ashish and his team have introduced products for AR and VR technology, which we hope will be a growth area moving forward. This team is adept at identifying trends, navigating challenges, and developing innovations to offset them. At this point, we have incorporated our expectations regarding the LCD-OLED transition into our 2023 guidance.

Yes. I would like to emphasize that we have been managing this transition for some time. Our innovation efforts are focused on collaborating with our customers in developing OLED displays and other applications. Historically, our electronics business has leaned heavily towards consumer electronics, and we aim to continue innovating in that area while also engaging with our customers well in advance. We are fully aware that significant growth is anticipated from other emerging segments. Monish highlighted AR and VR as a key opportunity, while automotive electrification is currently the largest driver. Additionally, we are exploring areas such as factory automation and electronic semiconductor manufacturing processes. We are committed to innovation in these sectors while preparing for new display technologies and mobile devices in consumer electronics.

Thank you.

Hi. Good morning.

Good morning, Julian.

Good morning. Maybe just wanted to start on the operating margins. So, sort of, backing into what you've talked about, are we right in assuming that the guide embeds sort of 19% operating margin for the year and sort of mid-teens in Q1? And then, on that Q1 aspect, very heavy decremental margins sequentially, even without the restructuring charge. Is there a lot of underproduction going on at 3M to clear out inventory, for example? Just trying to understand why that Q1 margin is so light. I think, it's like a 50% decremental or something excluding the restructuring.

Yes. So as I've always said, Julian, first is, volume gives us the best leverage. And what you have seen in Q4 continues into Q1. As we have said in Q4, we took some aggressive actions on making sure we rightsized our manufacturing facilities to help control inventory. Our plan is we will continue to aggressively manage production as a way to manage cash at the same time. So we're not building unnecessary inventory. So that's number one. I think number two is, as I mentioned, there's continued pressure on a year-over-year basis on foreign currency between 3% to 4%. If you look at it versus fourth-quarter exit rate, it's pretty much, I would say, flat to what fourth-quarter exit rate was. And then the other item, you mentioned the restructuring, but we also have other normal Q1 items that we have from an accounting basis that we take, which is normal in every quarter. And that's why the start to 1Q is slower. But as you accelerate or move through the year, volume and the supply chain healing are the two factors that will continue to drive us to get these margins better. And if we're looking at it on a year-over-year basis, it's all driven by the comps that we had last year, which impact us heavily. So it's lower volume in Q1 that's a big driver and volume will be the big determinant on what we think Q1 is going to be.

And, Monish, is that roughly right on that sort of mid-teens operating margin Q1 and 19-ish for the year in your guide?

Yes. Yes, it's actually close there. It's close enough, Julian.

Okay. Thanks a lot. And then one quick follow-up on that for Mike. Mike, you've announced a restructuring program today. I think it's the first kind of formal discrete one since the fourth quarter of 2020. And you had the business transformation savings program prior to that. Just wondered, sort of, when you think about the scope of the current restructuring plan, what kind of savings run rate we should expect annually when do you get to that? And how do you assess the scope of this as being enough to get margins back on track as you had those prior restructuring programs, but margins have stayed under pressure? Thank you.

Yeah, Julian, the way we're thinking about it. And like I said, this is certainly taking on what we see in the markets and in our performance and the supply chain dynamics that we're facing, all of that's part of what we're focused on as we look at these actions as we go through the year, adding to what we've already announced. And then we are thinking and getting ready for the spin-off healthcare. We're taking a deeper look, as I said, at everything we do. There's opportunities to streamline what we do as a company in the face of those end market dynamics and our operations. And we're learning from the changes that we've made to this point. So we'll continue to work on that. In terms of giving you a view of the impact of that, that's something we'll come back with as we make decisions and announce those actions, those additional actions as we go through there.

Thank you. Good morning, everyone, and thank you for all the 2023 planning assumption details.

Morning, Deane.

Hi, Deane.

I appreciate the first quarter guidance, even though it's not typical. My question pertains to the timing of the healthcare spin, which has been discussed a few times. Can you clarify the expected timeline? There have been concerns about potential legal challenges; what is the current status? Regarding the separation costs, how are they affecting 2023, and are they excluded as stranded costs? How soon can you address these issues? Thank you.

I'll discuss the spin-off briefly. Monish will cover the separation cost model. We have a dedicated team focused on developing the execution plans and we are making significant progress. We expect to complete the spin by late 2023 or early 2024, which is the priority for our teams as they work on this. There was some concern about a lawsuit related to the healthcare spin, but that case was dismissed. Therefore, this situation is not affecting us. Our main focus is on executing the spin and, as I mentioned, we are on the right track and moving forward effectively.

Regarding the guidance, Deane, as we mentioned during the announcement of the spin-off for healthcare, we currently do not plan to include it as an ongoing operation, so it will be treated as a special item. We cannot predict how much of it will be reflected in 2023, which is why it is not included in our guidance. However, when we announced the transaction, we indicated that the transaction costs for the spin-off would fall between $1 billion and $1.5 billion, encompassing both capital and operational expenditures. The teams are actively working on this as they progress. We have been engaged in this for the past four to five months, and as we derive better estimates, we will keep you updated. Additionally, regarding stranded costs, as Mike noted and we mentioned last quarter, this presents an opportunity for us to evaluate all our activities as we prepare for the spin. Our objective is to minimize stranded costs as much as possible, and we will continue to address this as we move forward. We will certainly inform you as we clarify these matters. The teams are dedicated and doing an excellent job ensuring the program remains on track.

Thanks. Good morning, everyone. We've covered a lot of ground here. But I want to go back to 1Q 2023, perhaps Monish. We calculate a 15% margin, which is kind of similar to Julian's mid-teens. I don't think we've ever seen a margin that low. I think the GFC, we saw 17% and change margin. So just wondering why margins will be so low. And I understand supply chain is a factor here, but why 15%? What's going on? And as part of this sort of question, the kind of the coverage of the full-year plan even at the low end of the range is still really, really low. So I think it's about 17% to 19% coverage, making a very big back-end loaded year. So I know you said volume gets better, but what gives you confidence and what can give investors confidence enough capture in the back half of the year?

Yes, I appreciate the questions. To address the first one, similar to my response to Julian, volume plays a crucial role in our leverage. When we look at the figures sequentially and account for foreign exchange adjustments that aided us compared to our prior guidance, we see flat volumes. We started January with low figures, which significantly impacts our fixed costs. Additionally, we have a restructuring charge and our tax rate stands at 19%. In terms of accounting, we also have typical first-quarter items to consider. Combining all these factors, the key takeaway is that volume has declined by 10% to 15% year-over-year. This is our toughest comparison, especially factoring in the impact of DR and the exit from Russia, both of which we have disclosed earlier. When we consider the company's margin of 46%, that also contributes to year-over-year pressure. Looking ahead through the remaining quarters, as you queried about margin prospects, once we move past these challenging comparisons, particularly the first quarter, we expect volumes and comparisons to improve. The supply chain efficiencies and various actions we initiated in the first quarter and some in the fourth quarter will start showing positive results throughout the year. It's important to note that some of these changes, especially regarding raw material costs, require time to work through our inventory. According to external data—since we cannot predict the future—there are indications that conditions will improve in the second half of the year, notably in China and globally. This gives us hope that as volumes recover in the second half, we should see improvements in our margins and revenue. However, we acknowledge that while we do not control the markets, we can manage our responses. We will continue to focus on driving supply chain efficiency and remain flexible. As Mike mentioned, we are carefully evaluating our actions and being cautious with hiring. The year 2023 is crucial for us as we plan to implement many strategic initiatives, including the spin-off of our healthcare business and enhancing our supply chain operations. To summarize your question, we are not pleased with our current position, and we will remain agile as we maneuver through our volume challenges. Our goal is to build on our current status and improve from here.

Hey, Nigel, I just want to correct one thing Monish said. Our total sales for Q1 are going to be down 10% to 15%, not volume.

I'm sorry. Yeah.

Hi. This is Dan Rizzo on for Laurence. Thanks. Thanks for fitting me in. I don't know if I missed this or not, but you mentioned that free cash flow conversion is 90% to 100% this year. Is that a long-term goal? Can you maintain that? I mean, as things kind of, I guess, will get less volatile in the out years?

Yeah, it's 90% to 100% for 2023, just to be clear, that was the guide.

Right.

For last year, we ended at 82%. As I've said multiple times, the opportunity for 3M's cash from a working capital comes from inventory management and EP. And to answer your question, is it sustainable; of course, it will ultimately depend on the income that we generated depends on how supply chains behave and the capital. But if you just look at the ability for us to use data and data analytics to help drive inventory and working capital clearly exists. In the fourth quarter, the teams did an amazing job to take inventories down; got it down by nearly $250 million. And as supply chains start to heal, this is clearly an opportunity for us, and we're going to keep driving that.

All right. Thank you very much.

Thanks.

To wrap up, we are focused on creating value for customers and shareholders in a challenging environment. We will continue to take actions to improve our performance, control costs and drive simplification while building 3M for the future. Thank you for joining us.