3M Co (MMM) Q2 2013 Results Earnings Call July 25, 2013 9:00 AM ET
Matt Ginter - Vice President, Investor Relations
Inge Thulin - Chairman, President and CEO
David Meline - Chief Financial Officer
Deane Dray - Citi Research
Steven Winoker - Sanford Bernstein
Shannon O'Callaghan - Nomura
Stephen Tusa - J.P. Morgan
Andrew Obin - Bank of America Merrill Lynch
Scott Davis - Barclays
Joseph Ritchie - Goldman Sachs
Ajay Kejriwal - FBR Capital Markets
Laurence Alexander - Jefferies
Nigel Coe - Morgan Stanley
Ladies and gentlemen, thank you for standing by. Welcome to the 3M Second Quarter 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, July 25, 2013.
I’d now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.
Thank you and good morning. With me here today are Inge Thulin, 3M’s Chairman of the Board, President and Chief Executive Officer; and David Meline, our Chief Financial Officer. Welcome to our second quarter business review.
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.
Before we begin, I’d like to mention a few calendar items. We will announce our third quarter earnings on Thursday, October 24th and our fourth quarter earnings on Thursday, January 30th. In addition, we’ll host an Investor Meeting on the afternoon of Tuesday, December 17th at the Grand Hyatt Hotel, in Midtown, Manhattan and for calendar purposes, please plan on 1 to 5 p.m. on that day.
If you turn to slide number two, please, 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.
So let’s begin today’s review and I’ll turn the program over Inge. Please turn to slide number three.
Thank you, Matt, and good morning, everyone. I appreciate you joining us for today’s call. Second quarter was another good one for 3M. We continue to grow our sales, profits and free cash flow in the face of a continued slow growth economy and a strong U.S. dollar.
Sales grew 3% year-on-year to $7.8 billion, an all-time record for any quarter in 3M’s history. Organic local currency growth was 2.3% in the quarter with Health Care leading the way at 6%. Industrial and consumer each grew 3%, and safety and graphics grew 2%. In electronics and energy, sales declined 2% on an organic local currency basis.
As I told you in each of the last two quarters, we expected a challenging consumer electronics market in the first half of 2013, and our prediction was correct. We continue to anticipate some recovery in the second half of 2013 in this business.
Geographically, Latin America, Canada led way with organic growth of 9%, Asia-Pacific and Europe, Middle East, Africa each grew 2% and the United States was up 1%. Currency impacts reduced worldwide sales by 1.3%, impacted by the weak Japanese yen. Acquisitions added nearly 2 points to second quarter growth.
Second quarter operating margins was strong at 22% on a GAAP basis or 22.4% adjusted for recent acquisitions. Earnings was $1.71 per share up 3% versus second quarter of 2012. Free cash flow in the in the quarter was $1.3 billion a second quarter record for 3M and we converted 107% on net income to cash.
Finally, in the quarter, we returned $1.6 billion of cash to shareholders via dividends and repurchases, a step up versus recent quarters. David will have more to say on this in a moment.
Entering 2013, we anticipated slow market growth in the first half of the year and that is how it played out. I’m pleased with our performance especially given this backdrop. We also expected a second half recovery based on improving macroeconomic trends and recovery in the consumer electronics. This remains our view today.
Please turn to slide number four. Looking at full year guidance, we are maintaining our previous expected earnings range of $6.60 to $6.85 per share and organic local currency sales growth of 2% to 5%. We now expected currency impact will reduce sales for the year by 2% versus the prior expected reduction of 1.5%. Acquisition should add about 1.5% of sales per year.
As for the 2013 tax rate, we now anticipate the range of 29% to 29.5% versus a previous range of 29.5% to 30%. And we continue to expect free cash flow conversion of 90% to 100% for 2013.
Now I turn the call over to David for details on the quarter .
Thank you, Inge. Let’s begin with slide number 5, where I will break down the second trend in sales. We generated organic local currency growth of 2.3% on midst of continuing challenging economy. Volumes contributed 1.7% for a growth and selling prices increased 1.6%.
Acquisitions added 1.9 points to sales growth in the quarter, the majority of which came from Ceradyne which was acquired by our industrial business in last year’s fourth quarter.
Foreign exchange impacts reduced sales by 1.3 percentage points in the second quarter, largely due to a 20% year-on-year decline in the Japanese Yen versus the U.S. dollar. In Dollar terms, worldwide sales grew 3% versus the second quarter of 2012. On a geographic basis, Latin America and Canada led the way again in this quarter with organic local currency growth of 8.5%.All five of our businesses posted positive growth in this region led by double digit results in Health Care.
Organic local currency growth Asia-Pacific was 2.2% in the second quarter, with Health Care again up double digits. Safety and graphics also had a nice growth in the quarter, China, Hong Kong, grew 3.4% organically in Q2 and Japan declined 2.3% year-on-year.
In EMEA or the combined Europe Middle East and Africa, second quarter sales increased 1.9% on an organic local currency basis. Four or five businesses posted positive growth lead by Health Care and industrial on a sub-EMEA level we achieved double digit organic growth in middle-east Africa and single digit growth in central East Europe. And organic growth turned positive in West Europe in the second quarter, which was encouraging to see after several down the quarters.
In United States, organic local currency growth was 0.8%, growth was positive on our Health Care, industrial and consumer businesses and declined in electronics and energy and in safety and graphics.
Let’s move to the income statement, please turn to slide number six. Second quarter sales were 7.8 billion up 3% in dollar terms. Our growth profit percentage was 48.3% down 30 basis points versus the second quarter of 2012. Investments in SG&A and R&D both increased 5% year-on-year, operating income was $1.7 billion down 1.5%.
Operating margins were 22%, down 90 basis points versus last year’s stronger Q2 results. Included in this quarter's results was a 40 basis points headwind from acquisition therefore underlying Q2 margins worth 22.4%. Profit leverage on organic volume growth added 20 basis points to second quarter operating margins and the combination of lower raw material costs and higher selling prices added 80 basis points.
In addition, lower year-on-year pension and OPEB expenses added 10 basis points to second quarter margins. Factory utilization reduced margins by 50 basis points, an improvement versus the first quarter and largely in line with our expectations. Strategic investments impacted margins by 40 basis points. This represents our ERP and business transformation effort along with more R&D aimed at disruptive innovation. Both will strengthen 3M for the future.
Finally, the combination of foreign exchange impacts, the recently enacted medical device tax in the U.S. and other factors reduced margins by 70 basis points year-on-year. Second quarter earnings were $1.71 per share, up 3% versus the second quarter of 2012. The second quarter tax rate improved to 27.4% versus 30.1% last year which added $0.06 to earnings and foreign exchange impacts reduced second quarter earnings by $0.02 per share.
Now let’s turn to cash flow, turn to slide number seven. Second quarter operating cash flow rose by $290 million year-on-year or 21% to $1.7 billion. The increase was due primarily to lower pension and OPEB contributions along with improved working capital. We invested $394 million in capital expenditures during the second quarter, up $36 million versus the second quarter of last year.
For the full year, we continue to expect capital expenditures in the range of $1.6 to $1.8 billion. Free cash flow rose by $254 million or 25% to $1.3 billion. Free cash flow conversion was 107% in Q2, a 19 point improvement versus the second quarter of 2012 and we continued to expect conversion of 90% to 100% for the full year.
Cash dividends paid were $436 million in the second quarter, up $26 million year-on-year. As a reminder, we increased the per share dividend by 8% this past February. This marks 55 consecutive years of dividend increases and the company has now paid a cash dividend for 96 consecutive years.
Gross share repurchases were $1.2 billion in the quarter, up $551 million compared to Q2 of 2012. And as Inge mentioned a step-up versus recent quarters, we now anticipate a range of $3.5 billion to $4.5 billion of gross repurchases for the full year 2013, versus a prior expectation of $2 billion to $3 billion.
We are increasing this range for a few reasons. One, our business is operating well and generating substantial free cash flow which we expect will continue. Two, rising interest rates are positively impacting our already well funded pension status. Three, we did not close any new acquisitions in the first half of 2013. And finally, our capital structure is already strong today and we do not intend to strengthen it further.
Let’s review in more depth our second quarter performance on a business-by-business basis starting with industrial. Please go to slide number eight. Second quarter sales were $2.7 billion in industrial, up 3.3% on an organic local currency basis.
Growth was strongest in the aerospace and automotive aftermarket businesses followed by liquid filtration, industrial adhesives and tapes and automotive OEM. Sales in industrial grew organically in all major geographic regions with Latin America and Canada up 9%, the U.S. and EMEA up 3%, and APAC up 2%. In November of 2012, we acquired Ceradyne, Inc one of the leading ceramics companies in the world. Ceradyne’s sales were $116 million in the second quarter which added 4.6% to industrial growth and the business was profitable on a GAAP basis. We are pleased thus far with the integration effort and look forward to continued success in this business. Second quarter operating income was $599 million and reported margins were 22.5%. Exact positions industrial operating margins were 23.2%.
Now let’s move to safety and graphics, turn to slide nine. Second quarter sales were $1.5 billion up 2% on an organic local currency basis. We generated a positive organic growth in commercial graphics, personal safety products, architectural markets and building and commercial services. Sales declined organically in the roofing granules business and in traffic safety and security systems. On a geographic basis organic local currency sales rose 9% in Latin America, Canada, 7% in Asia Pacific and 1% EMEA. The US declined 3% in the quarter. The FSTech acquisition added 1.1% growth in the quarter and the business is on track to meet its top and bottom line targets in 2013. We’re aggressively integrating this business to capture significant cost and sales synergies. FSTech increases our relevance in the large highway infrastructure market and is the natural growth (inaudible) for a reflected sheeting and pavement marking business. Operating income in safety and graphics was $333 million and operating margins were showing 22.9% against the very tough comp of 25.9% in the prior year. Excluding acquisitions, second quarter of 2000 operating margins were 23.8% and we’re investing to accelerate growth in this business particularly in personal safety in our recently formed mining, oil and gas business.
Next up is electronics and energy found on slide 10. In electronics and energy sales were $1.3 billion for the quarter down 2% in organic local currency terms. Operating income was $237 million and margins were 17.7%. As we anticipated margins were down year-on-year, but importantly showed nice improvement versus the 15.3% margin that we posted in the first quarter. Organic local currency sales declined slightly on the electronics side, consumer electronics and market demand has been fairly tepid throughout the first half of the year, but by and large the market seems to have stabilized and the third quarter sales should show recovery. End market inventories were heavy at year end and have improved as the first half has progressed with some modest [overwriting] still remaining in the hand held space.
And energy sales declined 4% in the second quarter. Our heartland electrical markets business had positive organic growth and continued to perform very well in Q2. This growth was more than offset by declines in other energy related businesses. Renewable energy in particular posted a double digit sales decline in the quarter, this market continues to seek a bottom which is impacting our growth. While we do see sales stabilizing in the second half and the comps begin to ease. We’ve been actively working to repurpose these assets for other 3M businesses where we anticipate growth. On a geographic basis organic local currency sales increased slightly in Latin America, Canada and declined in other regions.
Please go to slide 11. Health Care had another excellent quarter posting the highest organic growth and the highest operating margins amongst our five business segments. Sales totaled $1.3 billion up 6% on organic local currency basis. We continue to see broad based growth across much of the Health Care portfolio including health information systems, food safety, critical and chronic care, oral care and infection prevention. Sales in Health Care grew organically in all geographic regions, led by double-digit performances in both Latin America/Canada and Asia-Pacific.
Health Care second quarter organic sales growth was 15% in developing markets on top of 13% in the first quarter. These are highly promising growth sectors for 3M and we continue to funnel investment dollars towards them and we’re encouraged to see the positive results. In developed markets Health Care grew 8% organically in Japan and 3% in both U.S. and Western Europe.
Operating income rose 1% to $417 million and margins were again strong at 31.2%. The recently enacted U.S. medical device tax was a 40 basis point drag on Q2 operating margins.
Finally, let's review the Consumer business found on slide number 12. Consumer also delivered a good second quarter, sales were $1.1 billion, up 3% on an organic local currency basis.
Profits rose 4% to $235 million and operating margins rose 40 basis points year-on-year to 21.4%. We grew organically across the Consumer portfolio most notably in Consumer Health Care where ACE and FUTURO brands showed particularly good growth in the second quarter.
We also posted positive organic local currency growth in our home care, stationery and office and do-it-yourself businesses. Q2 is when we begin to see the impact of a back-to-school season and growth thus far has been encouraging. We have good placement in promotional programs in place and we’re seeing some sales lift from our newly introduced family of Scotch Expressions Tapes.
From a geographic perspective, organic sales growth was 7% in Latin America/Canada, 4% in Asia-Pacific and 2% in the U.S. Growth was slightly positive in EMEA.
In developing markets, the Consumer business grew 7% in organic local currency in Q2. Like Health Care, Consumer is one of our most significant growth opportunities in developing markets, as retail sectors expand along with the growing middle class. Developed markets grew 2% organically.
That wraps up the detailed outlook of the second quarter. Now, I will turn the call back over to Inge.
Thank you, David. Before we take your questions, I want to highlight our progress on several strategic fronts. Let’s start first with a brief update on the integration of Ceradyne, which we acquired in November of 2012.
Sales and profit exceeded expectations for the quarter, very good results and strong evidence of our progress. You’ll recall that earlier this year Ceradyne was awarded a $40 million plus order for protective armor plates. We saw some positive sales in fact from this win in the second quarter.
Let me also give some comments on our portfolio management efforts and our R&D investments. We are continuing to strengthen our portfolio through better product our decision and by addressing underperforming businesses.
For example, recently we announced a consolidation of our infrastructure protection division which or has been under strategic review into the electronic market division. We expect to gain rapid cost synergies as we increase the scale and efficiency on the newly combined entity. In addition, this division share common end markets such as construction, electrical utilities and electrical equipment manufacturing.
Back in May, we announced the sale of our fly fishing equipment business to Orvis. This is a good business and the market leader in its space, but it has no relevance to become important in the broader 3M portfolio.
We’re also making good progress in identifying new and promising technology programs. As you may recall, we’re planning to increase investments in longer term disruptive technologies, aimed at opportunities with significant growth potential. We formed a review team call the 3M Innovation Board, comprised by myself, David, our Chief Technology Officer and our Head of Corporate Strategy. The team meets quarterly to review milestone progresses and previously approved programs and to screen new investment ideas. I’m very encouraged of what I have seen so far.
Finally, we continue to move to move resources to our businesses with most promising growth opportunities. A great example is Health Care where the end markets continue to grow nicely and our technology and market positions gave us strong relevance with our customers.
Consumer is another example, where retail markets in developing economies are now beginning to develop. And we’re actively prioritizing our (inaudible) to ensure that they have the resources they need to improve their already strong market positions.
In summary, first half conditions were challenging and 3M executed very well under the circumstances. We anticipate demand recovery in the second half of the year with some help from both the macro economy and the consumer electronics markets. And we remain focused on driving productivity and executing our plan with strong discipline.
Thank you for your attention. We will now take your questions and comments.
Earnings Call Part 2: