3M Company (MMM) Q4 2013 Results Earnings Call January 30, 2014 9:00 AM ET

Executives

Matt Ginter - Vice President, Investor Relations

Inge Thulin - Chairman, President and CEO

David Meline - Chief Financial Officer

Analysts

Joe Ritchie - Goldman Sachs

Scott Davis - Barclays

Andrew Obin - Bank of America Merrill Lynch

David Begleiter - Deutsche Bank

Steven Winoker - Sanford Bernstein

Deane Dray - Citi Research

Laurence Alexander - Jefferies

Ajay Kejriwal - FBR Capital Markets

Shannon O'Callaghan - Nomura Securities

Drew Pierson - J.P. Morgan

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the 3M Fourth Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we’ll conduct a question-and-answer session. (Operator Instructions)

It is recommended that you use a landline phone if you’re going to register for a question. As a reminder, this conference is being recorded, Thursday, January 29, 2014.

I would now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.

Matt Ginter

Thank you and good morning everyone. On today’s call, we’ll discuss our fourth quarter and full year 2013 performance along with the 2014 outlook. Inge and David will make some opening comments and we will leave plenty of time for your questions.

Let me mention a few upcoming dates and events. First, our 2014 earnings conference calls are set for April 24 th , July 14 th and October 23 rd . Also, we’ll host an investor meeting on the morning of Tuesday, December 16. I know that calendar is filled quickly, please hold these dates. More details will be available later this year.

Note that today's earnings release and slide presentation accompanying the call are posted on our Investor Relations website at 3m.com under the heading Quarterly Earnings.

Please take a moment to read the forward-looking statement on Slide 2. 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.

Please turn to Slide 3 and I’ll turn the call over to Inge Thulin, 3M’s Chairman, President and Chief Executive Officer.

Inge Thulin

Thank you, Matt and good morning everyone. I appreciate you joining us for the call today. For 3M, 2013 was a very successful year. Our team did an excellent job of bringing our vision and strategy to life and increasing 3M’s relevance to customers around the world.

We delivered a strong performance and importantly, we advanced the company through the three key strategic levels, portfolio management, investment in research and development and business transformation. Let me give you a bit more on each of these key levels.

In 2013, portfolio management remained at the front of how we managed 3M. For example, we combined and scaled businesses in electronics and energy to better serve our customers, gain rapid cost synergies and address underperforming businesses. We took similar actions in Safety and Graphics to enhance our product offerings and improved our relevance to customers. And when it made sense, we exited as we did with the fly-fishing business within the consumer business group.

We continued to build strength on strengths by investing in research and development, which is the heartbeat of our plan. Our increased investment is focused on long term disruptive technologies aimed at opportunities with significant growth potential. We made good progress with business transformation enabled by our global ERP implementation. We rolled out in several countries in 2013 as we moved forward into the deployment phase. This effort will help us to create a more efficient and productive 3M.

Our teams are building on the experiences from the initial rollouts in order to improve our capabilities to deploy going forward. Overall very good execution by our team in these strategic levels.

At our investor meeting in December, we announced plans to better optimize our capital structure. These plans will reduce our total cost of capital, allow us to further expand the company and enable even higher returns to our shareholders. Organic growth remains key to our plans, so we will continue to invest in CapEx and research development. And we are planning to invest $5 billion to $10 billion in acquisitions through 2017 with more possible given the right strategic opportunity. We also announced in December a 35% increase of our first quarter 2014 dividend along with a stronger commitment to share repurchases.

Over the 2013 to 2017 planning period, we expect per share repurchases of $17 billion to $22 billion this is a prior expected range of $7.5 billion to $15 billion. This more aggressive deployment of capital reflects the strength of our business model and our confidence in 3M’s future.

Now I will review financial highlights from 2013. Please turn to slide four. For the year sales were nearly $31 billion, up 3.2% in dollar terms. Organic local currency growth was 3.4% led by Health Care and Industrial at 5% and Safety and Graphics at 4%.

Geographically, we posted positive organic growth in all regions. Latin America/Canada led away with organic growth of 7%, Asia-Pacific growth 4%, United States was up 3% and Europe/Middle East/Africa was up 2%.

Currency impacts reduced worldwide sales by 1.6% and acquisitions added 1.4% to sales growth for the year. Operating margins remained strong at 21.6% or 21.9%, excluding acquisitions.

Four of our five business groups delivered margins above 21%, evidence of continued broad based effectiveness and efficiency. Earnings were $6.72 per share, up 6.3% year-over-year. We returned a record $6.9 billion in cash to shareholders through dividends and share repurchases.

Finally, free cash flow conversion was 89% with return on invested capital at 20%. Overall, I'm very pleased with our 2013 results. We delivered good broad based performance while investing and building for long-term success.

Let me now review the outlook, please turn to slide five. We described our 2014 planning estimates in detail at our December Investor Meeting and we are maintaining those estimates today.

We expect 2014 earnings per share in the range of $7.30 to $7.55 and organic local currency growth of plus 3% to plus 6%. Foreign currency translation is expected to be neutral to minus 1% and we anticipate the tax rate of 28% to 29% with free cash flow conversion of 90% to 100%.

I will now turn the call over to David Meline for the detail on the fourth quarter results. David?

David Meline

Thank you, Inge. I will begin by reviewing the fourth quarter sales growth. Please turn to slide #6. Organic local currency growth was 3.4% in the fourth quarter, including organic volume growth of 2% and selling price increases of 1.4%.

Price increases have been positive in 2013 for a couple of reasons. First, investment in research and development continues to support a strong price value equation in many of the markets that we serve. And second, we adjust selling prices to offset currency devaluations in certain developing countries, which has been the case in 2013.

Acquisitions added 0.7 points to sales growth in the quarter, all due to Ceradyne in our Industrial Business group. We acquired Ceradyne in late November of 2012, so we are now passed the one-year mark and beginning with December reporting, we no longer report Ceradyne sales as acquisitions.

Foreign exchange impacts reduced sales by 1.7 percentage points in the fourth quarter. Currency impacts were negative 6% in Latin America/Canada and negative 5% in Asia-Pacific, while EMEA had a positive 3% currency impact year-on-year. On the total U.S. dollar basis, sales rose 2.4% versus the fourth quarter of 2012.

Looking geographically, local currency sales growth was 4.5% in the United States, the highest of any region during the quarter. All business groups grew organically in the U.S., with particular strength in Industrial and in Safety and Graphics.

Organic sales growth in EMEA was 3.4% in the fourth quarter, West Europe in particular grew by 3%, continuing the positive trends we have seen in recent quarters. In Germany the largest of our West Europe subsidiaries grew a solid 8% per organically. All businesses posted positive organic growth in the EMEA lead by Industrial. Asia Pacific grew 3.3% organically in the fourth quarter with consumer, Health Care and Safety and Graphics leading the way.

Industrial also posted positive organic growth in the fourth quarter within APAC and Electronics and Energy grew just slightly. Japan continued to grow nicely with 4% organic growth year on year. China, Hong Kong grew 1% organically versus a tough prior year comp off 16% plus in the fourth quarter of 2012.

Excluding electronics China, Hong Kong grew more than 6% organically in Q4. Organic local currency sales growth was 2.2% in Latin America, Canada during the fourth quarter which was below recent trend levels for a few reasons.

One, we saw some slowing in government tenders for infrastructure projects in certain countries which impacted sales in our Electronics and Energy business. Consumer was also soft in Q4 due to weak retail demand and challenging year-on-year accounts and lastly sales in Venezuela declined year-on-year due to economic and the political situation there.

Venezuela diluted fourth quarter organic growth in Latin America, Canada by 1.5 percentage points and we continue to work towards minimizing our (inaudible) exposure in any associated cost. Organic local currency growth was 4% across all developing markets and 3% in developed markets.

Let’s turn to Slide number 7 for a discussion of the fourth quarter income statement. Sales for the fourth quarter were $7.6 billion, an increase of 2.4% in dollar terms. Gross profit rose 5.8% to $3.6 billion and gross margins rose by a solid 1.5 percentage point to 47.5%.

SG&A spending increased in line with sales growth and R&D as a percent of sales rose by 10 basis points to 5.8%.

Operating income increased nearly 10% versus the fourth quarter of 2012. GAAP operating margins were 20.9%, up 140 basis points year-on-year. Organic volume growth at 20 basis points margins and the combination of lower raw material cost and higher selling prices contribute a positive 160 basis points year-on-year.

Fourth quarter margins improved year-on-year in a recently acquired Ceradyne business which added 30 basis points to total company operating margins in Q4. We expect further margin improvement in 2014 for this business. Strategic investments, reduced margins by 70 basis points year on year, this represents incremental investments in disruption R&D, ERP and various restructuring actions. Lower year-on-year pension and OPEB expenses boosted fourth quarter margins by 30 basis points while foreign exchange impacts reduced margins by 40 basis points.

Fourth quarter earnings increased 15% to $1.62 per share. Average diluted shares outstanding declined 3% year-on-year which added $0.05 to EPS and currency impacts hurt fourth quarter earnings per share by approximately $0.04. The fourth quarter concluded a good year for the company and the 3M team is energized and confident as we begin 2014. Now let’s turn to cash flow.

Please turn to Slide number 8. We generated $2 billion of operating cash flow in the quarter, up $255 million versus last year’s fourth quarter. Higher net income and lower pension contributions were the primary drivers of this improvement.

Capital expenditures were $543 million, an increase of $36 million. Looking ahead to 2014, we continue to expect full year CapEx will be in the range of $1.7 billion to $1.8 billion. Fourth quarter free cash flow was $1.5 billion, up $219 million year-on-year and we converted 131% of net income to cash versus 124% in last year's comparable quarter.

For the full year 2013, free cash flow was $4.2 billion and conversion was 89%. We paid $423 million in cash dividends during the quarter or $1.7 billion year-to-date. And as Inge mentioned, in December we announced a 35% increase in the first quarter 2014 dividend.

Gross share repurchases were $1.7 billion in the fourth quarter and $5.2 billion for the full year. For 2014, we expect full year gross share repurchases will be in the range of $3 billion to $5 billion. In total, we returned $2.1 billion in cash to shareholders in the fourth quarter or $6.9 billion for the full year, both at all-time record levels for 3M.

Net debt at year end 2013 increased $900 million year-on-year and $300 million sequentially. As I mentioned at our December investor meeting, we expect to add leverage of $2 billion to $4 billion in 2014, as we continue to improve the efficiency of our capital structure. During the fourth quarter, 3M issued an 8th-year Eurobond yielding less than 2%. The face amount was €600 million or $815 million.

Let's now review our fourth quarter performance on a business-by-business basis. Please go to Slide #9. Our Industrial business have another strong quarter with sales of $2.6 billion and 6% organic local currency growth.

Our advanced materials and automotive OEM businesses generated double-digit organic growth and we also posted good growth in 3M Purification, aerospace and automotive aftermarket. Organic local currency sales increased in all geographic regions led by the U.S. at 8%, EMEA grew 6% in Q4, including more than 10% in Germany. Organic growth was 3% in both Asia Pacific and in Latin American/Canada.

The Ceradyne acquisition added 2% to Industrial growth in the quarter. Fourth quarter operating income was $553 million, up 14% year-on-year and operating margins increased 150 basis points to 21.5%. Volume leverage, positive selling prices and good productivity contributed to the improvement.

Our Industrial business had an outstanding year in 2013. Organic sales growth accelerated in the second half of the year versus the first and sales exceeded $10 billion for the first time ever. Nice performance by the Industrial team.

Please turn to Slide #10. Our Health Care business generated sales of $1.4 billion in the fourth quarter. Sales rose 4% in organic local currency terms with the strongest growth in health information systems, food safety and critical and chronic care. Drug delivery systems declined in the quarter.

All geographic regions generated positive organic local currency sales growth with Asia Pacific up 6%, Latin America/Canada up 5% and EMEA and the U.S. each up 3% in the quarter. In developing markets, Health Care grew 10% organically in the fourth quarter.

This has been an area of strategic investment priority for some time and we are encouraged to see consistently strong organic growth as a result. Fourth quarter operating income in Health Care was $425 million. Operating margins were 31.2%, which was very much in line with full year. Fourth quarter margins were down a point year-on-year against a strong comp in Q4 2012. The recently enacted U.S. medical device tax was a contributing factor.

Please go to Slide #11, Safety and Graphics had a solid fourth quarter with 5% organic local currency sales growth and 16% growth in operating income. Organic growth was broad based with nearly all businesses posting positive growth.

Personal safety by far, our largest business within Safety and Graphics generated high single-digit organic growth in Q4. We also posted good growth in roofing granules, commercial graphics and architectural markets. Sales in Safety and Graphics grew organically in all major geographic regions with Latin America/Canada up 8%, Asia Pacific and the US up 6% and EMEA up 1%. Operating income increased 16% to $256 million and margins rose 2.2 percentage points to 19.1%. Profits benefited from volume leverage, price performance and solid productivity.

Now let's look at Electronics and Energy found on Slide 12. Fourth quarter sales in this business were $1.3 billion, up 0.4% in organic local currency terms and operating income rose 1% to $221 million. Margins were 16.7% up 40 basis points versus last year’s fourth quarter. I mentioned in our October earnings call that we expected sales and earnings for electronics and energy to be very close to last year’s levels and in fact that is what happened. Electronics related sales declined 2% on an organic local currency basis with positive growth in optical films offset by declines in other businesses. In our energy related businesses, sales increased 2% organically, led by our electrical markets and renewable energy businesses.

On a geographic basis, organic local currency sales increased 2% in EMEA and United States, Asia Pacific grew slightly and Latin America/Canada was down year-on-year. Despite challenging end market conditions, the electronic and energy team executed very well in 2013. Second half organic growth rates were stronger than the first as were operating margins. It was a good result in the tough market.

Finally, let's review the Consumer business found on Slide number 13. Sales on the consumer business group were $1.1 billion with organic local currency growth of 1.3%. Recall that in the fourth quarter of 2012 consumer generated 9% organic local currency growth, so the comp here was quite challenging. Organic sales growth was strongest in our consumer Health Care and home care businesses and we also had a positive organic growth in DIY. Sales declined slightly in stationary and office supplies impacted by continued consolidation trends in the office retail and also market.

On the positive side, we recently launched a new line of command and ease of products for outdoor use which contributed nicely to fourth quarter growth. The US retail shopping season is an important factor for the consumer business and we would characterize this year’s season is okay but not strong. Fewer shopping days due to the late Thanksgiving holiday were a factor for most major US retailers and for their suppliers. On a geographic basis, sales in organic local currencies increased 9% in Asia Pacific and rose slightly in both the US and EMEA, Latin America/Canada declined 6% year-on-year. Operating income was $226 million with operating margins of 20.4%.

That concludes my comments regarding 3M’s fourth quarter business results. I’ll turn now the call back to Inge.

Inge Thulin

Thank you, David. To summarize, Q4 was a strong finish to a very successful year for 3M. In 2013 we received good growth and solid profitability while advancing our strategic initiatives in investments. Perhaps most importantly, we came out of 2013 stronger than we ever at with both sales and earnings growth accelerating in the second half of the year, this was the first. 2013 results provided further proof that our strategies are gaining traction and driving our performance to higher levels. I can think of numerous example that illustrate is but I will highlight just a couple.

Let's start with our $1.4 billion automotive OEM business which in 2013 grew over 7% organically more than twice the rate of global auto production. We see this result through improved customer relevance, leveraging 3M’s vast technology capability to solve problems for this important group of OEM customers. This business grew significantly in Q4 in developing markets like China, Mexico and Indonesia by offering relevant solutions to these rapidly growing markets.

Another example is our safety and graphic business group. We saw margins expand by more than two points in the fourth quarter. This improvement is due to cost through several recent portfolio actions, which have resulted in improved customer relevance, greater scale and reduce costs. We also saw improved profitability on recent acquisitions in this business. These are two powerful examples of many that illustrate how the strategies are pushing 3M’s performance through new level.

In closing, I want to recognize the people of 3M for their many contributions that continued our success as a company. We have great confidence and good momentum as we enter 2014. Our teams are focused on executing our plan and creating even greater value for customers and our shareholders. Thank you for your attention this morning and we will now take your questions.

Earnings Call Part 2:

• Q&A with 3M Company CEO