3M : Transcript (includes corrective disclosure on page 12)

Q4 2021 Earnings Call Transcript

Michael Roman & Monish Patolawala

January 25, 2022

Note: Transcript includes corrective disclosure on page 12

Slide 1, Cover page

Bruce Jermeland, Senior Vice President, Investor Relations

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 will 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.

Slide 2, Events

Bruce Jermeland, Senior Vice President, Investor Relations

Before we begin, I would like to announce our next two investor events. On the morning of February 14th, we will be having a virtual investor meeting where we will be providing a near-term strategic update along with our 2022 guidance.

Also, please mark your calendars for our first quarter earnings conference call which will take place on Tuesday, April 26th.

Slide 3, Forward looking statement

Bruce Jermeland, Senior Vice President, Investor Relations

Please take a moment to read the forward-looking statement on slide three. During today's conference call, we will 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 note, throughout today's presentation we will 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 and highlight a couple of presentation changes we are making in 2022 to simplify our financial reporting and increase understanding of our performance.

These changes are a result of discussions we have had with many of you over the last few years along with recent benchmarking work that we have done.

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First, we recognize that dual credit reporting has presented some challenges, for example, having a clear understanding of the impact of disposable respirator performance over the past two years on our segment results, particularly Safety & Industrial and Health Care.

Therefore, we have decided to eliminate dual credit reporting and will no longer report dual credit within our business segments starting in Q1 2022. We will provide a Form 8K ahead our February 14th meeting with updated history for the past three years reflecting this change.

And second, we will be providing organic sales change components in aggregate as opposed to reporting separate volume and price components. With this change, we will also be updating the descriptor to "organic sales" versus "organic local-currency sales". Please note this change will be reflected in our 2021 Form 10-K filing.

We remain committed to providing strong transparency of reporting our financial performance, and of course, we are always here to address your questions.

With that, please turn to slide four and I will now hand the call off to Mike.

Mike.

Slide 4, Serving customers while navigating external challenges

Mike Roman, Chairman and Chief Executive Officer

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

3M delivered a solid performance in the fourth quarter, closing out a strong year as we focused on serving customers in a dynamic external environment.

Our revenue in the quarter finished better than we expected across all businesses, including an increase in respirator demand due to the impact from the Omicron variant.

Organic growth companywide was 1 percent, on top of 6 percent in last year's Q4 with earnings of $2.31 per share, driven by a good December, strong execution, and a lower than anticipated tax rate.

I am pleased with how we effectively managed production operations to meet customer demand, despite ongoing logistics and raw material challenges that are impacting many companies.

While focusing on customers, we also saw good benefits from our actions to drive productivity, improve yields and control costs, which helped offset the margin impact of supply chain disruptions, inflation and COVID-19.

In addition, our selling price actions continued to gain traction, with a year-on-year increase of 2.6 percent in Q4, versus 1.4 percent in Q3. We expect this to be a tailwind for the full year in 2022.

Overall, demand remains strong across our market-leading businesses, and we are continuing to prioritize growth investments in large, attractive markets.

We also took actions to strengthen our portfolio and advance our commitment to sustainability. I will highlight examples of our progress later in the call.

In summary, we delivered a good finish to the year, and are well positioned to drive growth in 2022. As Bruce noted, we will provide full-year guidance, along with strategic updates from our business leaders, at our February 14th meeting.

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Monish will now take you through the details of the quarter.

Monish.

Slide 5, Q4 2021 operating margin and EPS

Monish Patolawala, Executive Vice President, Chief Financial and Transformation Officer

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

Please turn to slide five.

Looking back on the fourth quarter, the 3M team continued to manage through a challenging environment. As Mike noted, revenues for December were better than previously expected across all the businesses, including disposable respirators, as the Omicron variant increased near-term demand.

Though manufacturing, raw materials and logistics challenges persisted throughout the quarter, the 3M team executed well by driving operating rigor and managing costs while continuing to invest in the business.

Turning to the fourth-quarter financial results, sales were 8.6 billion dollars, up 0.3 percent year-on-year, or an increase of 1.3 percent on an organic local-currency basis against our toughest quarterly comparison last year.

Operating income was 1.6 billion dollars with operating margins of 18.8 percent and earnings per share of 2 dollars and 31 cents.

On this slide you can see the components that impacted our operating margins and earnings per share performance as compared to Q4 last year.

The biggest impact to fourth quarter results was the ongoing effects from the well-known global supply chain, raw materials, and logistics challenges, which persisted throughout the fourth quarter.

Our Enterprise Operations teams continued to work tirelessly through ever evolving changes in customer demand while navigating these challenges to keep our factories running, serve our customers and protect the health and safety of our employees.

We continued to experience significant productivity headwinds in our factories due to shorter production runs and more frequent production changeovers throughout the quarter, as we focused on serving our customers.

As forecasted at the start of last year, we also had higher year-on-year compensation and benefits costs.

These impacts were partially offset through strong spending discipline along with benefits from restructuring and lower legal-related expenses versus last year's Q4.

We also continued to prioritize investments in growth, productivity, and sustainability to drive long-term performance and capitalize on trends in large, attractive markets including automotive, home improvement, safety, health care and electronics.

All in, these impacts lowered operating margins by 2.4 percentage points and earnings per share by 33 cents year- on-year.

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Moving to price and raw materials, as expected, our selling price actions continued to gain traction as we went through the quarter. On a year-on-year perspective, Q4 selling prices increased 260 basis points as compared to 140 basis points in Q3 and 10 basis points in Q2.

In dollar terms, higher year-on-year selling prices offset raw materials and logistics cost inflation in Q4 which resulted in an increase in earnings of 3-cents, however, remained a headwind of 20 basis points to operating margins.

Next, foreign currency net of hedging impacts was a headwind of 10-basis points to margins and 4 cents per share year-on-year.

There were three other non-operating items that impacted our year-on-year earnings per share performance.

• First, a reduction in other expense resulted in a 10-cent earnings benefit. This included a 6-cent benefit from non-operating pension which was similar to prior quarters. We also have been proactively managing our debt portfolio including the early redemption of one and a half billion dollars which helped drive a 4-cent benefit year-on-year from lower net interest expense.
• Second, a lower tax rate versus last year provided a 12-cent benefit to earnings per share. Our Q4 tax rate was benefitted by geographic income mix and favorable adjustments related to impacts of U.S. international tax provisions. And for the full year, our tax rate was 17.8 percent.
• And finally, average diluted shares outstanding decreased one percent versus Q4 last year … increasing per share earnings by 2 cents.

Please turn to slide six for a discussion of our cash flow and balance sheet.

Slide 6, Q4 2021 cash flow and balance sheet

Monish Patolawala, Executive Vice President, Chief Financial and Transformation Officer

Fourth quarter adjusted free cash flow was 1.5 billion dollars, or down 30 percent year-on-year with conversion of 110 percent.

For the full year, adjusted free cash flow was 6 billion dollars with adjusted free cash flow conversion of 101 percent.

The decline in our Q4 year-on-year free cash flow performance was driven primarily by lower non-cash legal and restructuring expenses versus Q4 last year, along with higher litigation-related payments and capex investments, which was partially offset by improvements in working capital velocity.

Fourth quarter capital expenditures were 556 million dollars, up 134 million dollars year-on-year and 213 million dollars sequentially as we continued to invest in growth, productivity, and sustainability. Looking at the full year, capital expenditures totaled 1.6 billion dollars.

During the quarter, we returned 1.8 billion dollars to shareholders through the combination of cash dividends of 848 million dollars and share repurchases of 938 million dollars.

For the full year, we returned 5.6 billion dollars to shareholders in the form of dividends and share repurchases.

Our strong fourth quarter cash flow generation and disciplined capital allocation enabled us to continue to maintain a strong capital structure.

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We ended the year with 4.8 billion dollars in cash and marketable securities on-hand and reduced net debt by 1.2 billion dollars, or 8 percent versus year-end 2020.

As a result, we exited the year with net debt to EBITDA of 1.4 times.

Our strong balance sheet and cash flow generation capability, along with disciplined capital allocation, continues to provide us the financial flexibility to invest in our business, pursue strategic opportunities and return cash to shareholders while maintaining a strong capital structure.

Please turn to slide seven where I will summarize the business group performance for Q4.

Slide 7, Business Group performance

Monish Patolawala, Executive Vice President, Chief Financial and Transformation Officer

I will start with our Safety and Industrial business which posted an organic sales decline of 1.3 percent year-on-year in the fourth quarter. This result included a disposable respirator sales decline of approximately 110 million dollars year-on-year, which negatively impacted Safety and Industrial's Q4 organic growth by nearly 4 percentage points.

Our personal safety business declined mid-teens organically versus last year's 40 percent pandemic-driven comparison.

Looking ahead, we anticipate that COVID-related disposable respirator demand will decline as we move through 2022. However, we remain prepared to respond to changes in demand as COVID-related impacts continue to evolve.

Turning to the rest of Safety and Industrial, organic growth was led by a double-digit increase in closure and masking.

In addition, the abrasives business was up high single digits, industrial adhesives and tapes and electrical markets were each up mid-single digits, automotive aftermarket was flat, while roofing granules declined against a strong comparison from last year.

Safety and Industrial's fourth quarter operating income was 543 million dollars, down 22 percent versus last year. Operating margins were 17.7 percent down 440 basis points versus Q4 last year.

Year-on-year operating margin performance was impacted by a decline in sales volumes, higher raw materials, logistics, and litigation-related costs, manufacturing productivity impacts, along with last year's gain on sale of property. Partially offsetting these impacts were selling price increases, strong spending discipline, net benefits from restructuring and a smaller increase to our respirator mask reserve.

Moving to Transportation and Electronics which declined slightly on an organic basis due to the continued impact of the semiconductor supply chain constraints.

Our auto OEM business was down mid-teens organically year-on-year compared to the 13 percent decline in global car and light truck builds.

As we mentioned last quarter, we experienced an increase in channel inventory levels with the tier suppliers in Q3 as auto OEM production volumes decelerated from 18.5 million builds in Q2 to 16.3 million in Q3.

During the fourth-quarter, OEM production volumes increased to 20.2 million builds, or up over 20 percent sequentially. This sequential increase in build activity drove a reduction of channel inventory levels with the tier suppliers during the quarter which negatively impacted Q4 organic growth for our automotive business by approximately 10 percentage points.

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