3M Company — 2024 Q1

Thank you, and good morning, everyone, and welcome to our first quarter earnings conference call. With me today are Mike Roman, 3M's Chairman and Chief Executive Officer; and Monish Patolawala, our President and Chief Financial 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.

Thank you, Bruce. Good morning, everyone, and thank you for joining us.

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Thank you, Mike, and I wish you all a very good morning.

Thanks, Monish.

Congratulations, Mike, on the transition. And obviously, you'll stay very involved in the Executive Chairman role.

Yes. Thank you, Julian.

Absolutely. Maybe just to start off with, Monish, you packed a lot of clarification on the moving parts into the prepared remarks. Maybe just to try and understand a little bit better the quarterly sort of cadence here. So it sounds like second quarter EPS, down slightly maybe versus the sort of [ 170 ] comp ops number for Q1, and that's really because of the stock comp and the one-timers that you talked about.

Yes. I would say, Julian, so you summarized it. I would go back and say there's so many moving pieces that I would really say first look at first half, second half. And then when you do that, we would also show you that on revenue, we are starting to hit normal seasonality trends.

That's very helpful. And then maybe a second question, perhaps more for Mike, but on capital allocation. So clearly, you and the Board spent a lot of time thinking about balance sheet leverage of 3M to settle on that sort of 40% dividend payout ratio. You also mentioned, though, on the buyback some step-up since the Solventum spin. So maybe help us understand kind of how you and the Board are thinking about 3M's leverage requirements from here. How meaningful could a buyback be? And then tied to that, Monish, any clarification on interest expense guide for this year based on that balance sheet?

Sure, Julian. I would start with we continue to be a strong cash generator, and we're well capitalized to invest in our business, which is -- continues to be the first priority for capital allocation and also return capital to shareholders, including the dividend that we've been talking about and share repurchases.

Julian, I'll answer your second question. When we talk about below-the-line items, we talk about 2 things: mainly it's pension and it's interest expense/income. So I'll combine the 2. So our guide is net expense of $75 million to $100 million or $0.10 to $0.15 per share. Q2, as I mentioned, will continue to benefit from the interest income that we receive from the -- dividend that we receive from Solventum of $7.7 billion. And so therefore, the $75 million to the $100 million guide for the year will mostly be weighted to the second half of the year.

Mike, hopefully, the Exec Chairman role is a bit less stressful than Chairman and CEO role. So congratulations on that. So just a few more -- maybe a few more details on the 2Q, Monish. The restructuring -- and I understand 70% in the first half, 30% in the second half. How does that phase between 1Q and 2Q? I'm just trying to understand whether that's fairly level-loaded or whether there's a bit more coming through in the second quarter.

Yes. So I'll start with the first one, Nigel. As I said, it's 70% weighted in the first half of the $250 million to $300 million range. In the first quarter, at a holdco basis, we did $122 million of restructuring that I've said in my announcement, and then you'll see Health Care was approximately $20 million of that. So you've got $100 million that is on a RemainCo basis. And so the balance is -- so you can get the math.

Great. My follow-up question is on the dividend. There's been a huge sort of [ core ] industry about the potential dividend scenarios, but hopefully, that's now behind us. But the 40% payout ratio on adjusted free cash flow, is the intent, Mike, to keep that 40% relatively stable going forward, so as you grow earnings and free cash flow going forward, the dividend should increase as well?

Yes, I would think of it as a guide of how we're thinking about it. The approximately 40% of adjusted free cash flow, that's the way the Board -- that's the guide that the Board is looking at as we go forward. So I -- that's where we start as we go forward with continuing operations. That's the best way to think about it, Nigel.

Mike, thanks for all your help over the years. Congratulations.

Thanks.

Can you update us on your industrial channels within Safety and Industrial? Are they generally to the point where you have better visibility and destocking is mostly over? And it does seem like -- for instance, Industrial Adhesives and Tapes has been turning the corner over the last couple of quarters. Is that a bit of a canary in the short-cycle industrial businesses that you have?

Yes. Andy, I would say if you look at inventory in the channels as kind of a measure of that, that's -- I would say it's been reducing some of the inventory in the channel really around improving supply chains. We talked a bit about this last quarter. As supply chains improve, our distributors in the channel are taking advantage of shorter-cycle times and managing down some of their inventory.

That's helpful, Mike. And then, Monish, obviously, you mentioned the relatively good T&E start. You did have a pretty easy comparison in Q1. But 7% growth, you're still guiding of low single digits. I know it's up a little bit. You mentioned the buy ahead was a big part of the Q1 improvement. But is there any reason why your improved spec-ins wouldn't continue in electronics? And then are you seeing any improvement at all yet in semiconductors and those kind of end markets?

Yes. I would say, first, we are thrilled that we've got the spec-ins, so that's a big positive. As I said, 2/3 of the total, 6.7%, that's approximate. We don't have the perfect number. We believe it's partly driven by inventory normalization both in auto and electronics, plus customers starting to buy ahead as they start building for end markets or consumer end markets.

Best of luck to you, Mike, in your next endeavors, et cetera.

Thanks, Scott.

Guys, I had a couple. I'll just start with a [ knit ] and then ask a real question. But why -- I'm looking at Slide 27. Why does the 2026 payment dip? What was kind of the -- just walk us through a little bit of the color of the kind of how these payments were negotiated annually.

Yes. So there were so many facts that were put together, Scott. This is one of them on how these profiles were scheduled. So there's no particular reason to give it out to you. This was a lot of factors, pluses and minuses that put the whole agreement together.

Okay. So there's nothing specific in there that 2026, you'd...

No.

I can take it off-line.

Yes.

Okay. More importantly, Mike, if you look back at the long-term growth rate ex Health Care of 3M, it's been kind of sub-2%, so below GDP. And that includes some price inevitably, I would assume. What do you think the entitlement growth rate of this business is longer term? I mean just go back 10 years, so I think that's a full cycle for sure. But when you think about the next 3 or 5 years, what do you think that the business should be able to grow at? Obviously, Bill is going to have his own initiatives. But what is your view on that?

Yes. Scott, I won't get ahead of Bill and kind of how he's going to think about going forward. You saw our guidance for this year, it's in line with macro. Importantly, when you look at what drives our growth, it's really investing in the business. The organic investments have been the dominant driver of growth for us as a company, and we expect that to continue as we move forward.

Totally fair. I'll pass it on, but congrats on getting all this work done the last year. It's -- I'm sure it's been a lot of heavy-lifting. So congrats and best of luck this year.

Thanks, Scott.

Thank you.

It's Andrew Obin. Mike, congratulations, and great job getting all this legal stuff out of the way.

Thanks, Andrew.

Yes. So I would take an issue with Scott's statement about lack of growth at 3M. I don't know where he's getting his numbers because pre-COVID, company has grown at, on average, at 3.7% organically based on my model. So I actually have the exact opposite question. What is this, for example, safety and growth, right? You say that industrial production is growing 2%, yet the guidance is 0% to 2%. You have 100 bps sort of this portfolio geography drag.

Yes. Andrew, it's kind of building on maybe my answer to Scott. The macro is an important part of this, and we think about the macro for us -- for 3M is a combination of GDP where we have our Consumer business, and then it's also around industrial production in a broader industrial and transportation and electronics. But importantly, we go down and we really look at the markets that we're part of.

Right. And then maybe just a follow-up. I know you guys are tweaking your global distribution, exiting some, right, direct distribution. You are starting to utilize distributors. Can you just talk about sort of what have you experienced so far with these changes to the models? What are the pros and cons? Because some of the commentary referred is that 3M is leaving money on the table with its distributor, some sort of legal risk associated. How do you mitigate those? And what has the experience been so far?

Yes. Andrew, just talking about the change, so this was part of the restructuring -- actually was part of the model change that we've been making, really focusing on leading through our businesses globally and prioritizing where they -- the most important parts of their business and looking at what's the best model to put in place. And so geographic prioritization was the way we termed it.

It also helps us -- to add on to Mike's comments on pros, benefits, you take a lot of structure out from those countries, that also has benefited us on the margin line. It also helps us focus our portfolio. Like what are we going to sell? And therefore, it's SKU rationalization that once you get through this, you will have a different inventory profile that support those smaller countries. So they're still very important countries for us. In no way are we walking away. It's just a different way of approaching them.

Mike, I echo all the best of luck, congratulations.

Thanks, Joe.

I'm going to start just -- just let us start with a quick just clarification. So just apologies if I missed it, like Slide 15, where you give the operating income number of $1.2 billion. So if I just kind of back out the performance this quarter, it assumes Health Care stranded cost of roughly $100 million to $150 million goes to the segment. So I just want to make sure I have that right.

So try me again on the first piece of the question because I didn't follow exactly. But I'll answer your second one. So the $250 million to the $300 million is embedded in here, and that's on a continuing ops basis. So that does not include Health Care.

Okay. All right. Great. Yes. So just on the operating income quickly, I think you guys have roughly $1.7 billion this quarter. I think we had like roughly, call it, $350 million or so in Health Care profit. So you back that out, that's above the $1.2 billion number. So I was just basically trying to understand how much the Health Care stranded costs go into the other segments.

Yes. So I think that there are 2 pieces to this. One is the dis-synergies of Health Care, which on an annualized basis right now, we think it's $150 million to $175 million. And then the second piece of this is, as I've mentioned, there's $250 million of cost that we hold on behalf of Solventum for which you get reimbursed in April 1 onwards. So you eat Q1 with no reimbursement basically.

Got it. Okay. No, I think I've got it and can follow up afterwards...

Yes, Bruce can follow up off-line with you.

Yes, yes. And then just another quick follow-up on the electronics business. And so I know the stats you kind of gave on demand and then inventory normalization. Is it possible to kind of parse out the inventory benefit that you're seeing? I'm just curious like how much of that 15% came from just inventories normalizing just because -- maybe I'm just not close to it anymore. But I'm just curious, like what other like products are really kind of driving end-market demand for electronics at this point?

Yes. Joe, what we talked about in the results for TEBG in the first quarter in electronics, these are spec-in wins on some of the mobile platforms. And so the inventory, it's getting ready for the demand, really the demand that they're seeing into the second quarter. And at this point, it's really -- that's the step-up. And then there's a portion of it that's inventory kind of filling into the value chain of those OEMs. But it's -- the bigger part of it is the spec-in -- for us, anyway, the bigger part of it is the wins in the spec-in side of it.

And Mike, that's smartphone demand?

It's mobile devices, largely phones. Yes, yes, largely phones.

Mike, congrats again, and thanks for all the help over the years and the effort.

Yes. Thanks, Steve. Thanks.

Just to be clear, you said 40% of adjusted free cash flow. Can you just help us with what the construct of that is? What is adjusted free cash flow?

You're referring to the dividend, Steve, I presume?

Yes, just the construct. I don't need a number for cash. Just how do you define that adjusted free cash?

Yes. So if you look at all our material that we have submitted, you will see historically what we have broken out is from our GAAP results, there are certain items that we have been adjusting to get to adjusted results, which is litigation expenses. Number one. Number two is PFAS because we've been exiting -- we've been showing PFAS as an exit. And number three was all the costs incurred to spin out Solventum or the Health Care business.

Yes. Steve, it's all detailed in our press release attachments.

Right. So whatever you're paying out in cash for these liabilities, that is adjusted out of free cash. So for example, the $4.3 billion or whatever in this year will be adjusted out, and then you take whatever we want to assume for free cash flow and then take 40% of that?

Correct.

Correct.

Thanks for clarifying that on the dividend. That was a key question. Also, I just wonder, to any degree, has Bill Brown been involved in the kind of the formulation of the updated guidance here, whether explicitly or tacitly? And I know he's formally starting tomorrow, but just any color on that would be interesting and helpful.

Sure, Jeff. Bill is, as you would expect, getting ready to step into the role. He's been engaged with myself and senior management and the Board since the announcement. But he's really -- his part is being informed and getting ready to start, as you said, tomorrow. He's not part of the decisions on what we've laid out here in the earnings call today. So he starts tomorrow. Bill starts tomorrow, and I look forward to working with him as he does.

Great. And then just thinking about, again, the cash flows as it relates to the liability outflow that we're looking at here. What guidance, if any, could you provide on what you're thinking on insurance recoveries? And if you're successful in those claims, when those might start flowing as potential offsets to the liability schedule?

Yes. So we believe that we are eligible for insurance payments. We have put our insurance providers on notice for PWS and for Combat Arms. And in fact, for Combat Arms, we have -- we are working on an arbitration to recover that. So as you know, these things take some time to work through, and that's what the teams are working on. And we'll keep you posted as soon as we come to know on what that number could look like.

Congrats to Mike.

Thanks, Brett.

Yes. I want to come back to the portfolio and the geographic prioritization. So you called out the 100 basis points headwind in '24. Should we think of the first quarter as the starting point and just simply anniversary that headwind for the balance of the year and it's complete? Or is this more of a multiyear initiative with some top line drag?

So there's a little bit of drag next year, but I -- it's not big. I would just say the first half of this year will be slightly heavier than the second. But directionally, I would say, yes, you can use the first quarter as the math that gets you across the 4 quarters.

Okay. Great. I guess the follow-up, you called out some contribution from those initiatives in each of the segments. Are you able to size what that benefit is? And I would imagine it's sort of structural, but any color would be great.

Yes. I would just say when we look at it in total is why are we doing these portfolio moves or geographic moves. It comes down to it allows us to do better focus, better prioritization. So at the end of the day, you're going to see it in multiple places. You're going to see better sales growth in other products because we're exiting these and the teams can focus, whether it's ad, merch, et cetera.

I wanted to ask on PFAS, and you've talked about the exits there, kind of progressing to plan, if not a little bit ahead of plan. But just how do we think about alternatives? I think there's been press over the years on different applications across a number of different end markets when we think about semiconductors or military or auto. Do you expect to participate in that? I mean, where are you on the sort of product innovation pipeline and being able to sort of provide alternative products to what you're exiting?

Yes. And Joe, as I said in my comments, we work with each of our customers as part of the transition. I would say there's kind of 3 alternatives for them. One is PFAS from another source. A number of the applications, many of the significant applications, they're challenged to find an alternative. So that's what they're looking to do is source PFAS from another supplier.

That's helpful. And then second question is just related to CERCLA designation and really just trying to understand what the designation versus not getting the designation means at a high level. I think when you first announced this being proposed, you talked about how 3M's view was this would not lead to a timely or appropriate kind of remediation. But just to try to understand, having the designation versus not having it at the end of the day, kind of what that means.

Yes. There are certain, I would say, EPA responsibilities that would come with CERCLA designation. We, at this point, we don't anticipate an impact on our ability to serve customers. And we'll -- as we better understand all of those requirements, and we're committed to meeting and complying with the requirements under CERCLA and the EPA guidelines.

My congrats to Mike and also to the team on orchestrating all these moving parts.

Yes. Thanks, Deane.

Thank you, Deane.

And just a quick follow-up on that last PFAS question. So the enforcement actions by the EPA, they set PFAS as hazardous. So that's a milestone and then in the process of setting up the Superfund. So would either of these actions put you closer to be able to set a reserves? I know you couldn't before for accounting purposes. It was not estimable or the probable, but now we're closer to that. So are you closer to where you could be setting reserves for these remaining unaddressed PFAS liabilities?

Yes. Deane, we are -- as I've said a number of times, we're proactively managing this, all aspects of the PFAS dynamic. And as soon as we can get to probable and estimable, we will take the reserves. And we'll keep you informed, and I would refer to our SEC filings for updates.

That's really helpful. And just one other one, I'm sorry. Is there any scenario where 3M would continue to manufacture PFAS after the year-end 2025 target?

No, Deane, we're committed to that exit. We're on track, and we're committed to follow through.

This concludes my last earnings call as 3M's CEO. I would like to thank the investors, shareholders, analysts, employees and family who join these calls each quarter. I greatly appreciate your questions and diligence in working to better understand our company. I'm confident that under Bill's leadership, our people will continue to build on the momentum from our strong start to the year.