3M Co (MMM) Q3 2013 Results Earnings Call October 24, 2013 9:00 AM ET
Matt Ginter - Vice President, Investor Relations
Inge Thulin - Chairman, President and CEO
David Meline - Chief Financial Officer
Scott Davis - Barclays
Ajay Kejriwal - FBR
Steven Winoker - Sanford Bernstein
Andrew Obin - Bank of America, Merrill Lynch
Deane Dray – Citi Research
Laurence Alexander - Jefferies
Joe Ritchie - Goldman Sachs
Shannon O'Callaghan - Nomura
Stephen Tusa – JP Morgan
Nigel Coe - Morgan Stanley
Ladies and gentlemen, thank you for standing by. Welcome to the 3M Third 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, October 24, 2013.
I would now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.
Thank you and good morning. Here with me 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 third 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 address a few upcoming events highlighted on slide number two. First, we have set the dates for our 2014 earnings calls. They are January 30th, April 24th, July 24th and October 23rd.
Second, we’ll host an Investor Meeting in the afternoon of Tuesday, December 17th at the Grand Hyatt Hotel, in Midtown, Manhattan. We plan to have several presenters on hand for this event, including many members of our senior leadership team.
Inge will provide the keynote presentation, highlighting 3M’s progress on key strategic initiatives and objectives, and heads of our five business segments in international operations will highlight their respective businesses.
Finally, David will provide the status update to the five-year plan that we introduced in November of 2012 including capital structure and capital allocation, and of course, we will articulate our 2014 earnings outlook. Invitations for this event will be sent this afternoon, so please RSVP as soon as possible and we hope to see you there.
Please turn to slide number three, 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, I’ll turn the program over Inge. Please turn to Slide number four.
Thank you, Matt, and good morning everyone. As always, I appreciate you joining us for today. I’m pleased to report that Q3 was a strong quarter for 3M. We posted an all-time record for quarterly sales and every business grew sales organically. All five business groups posted margins above 20% while we continued to advance our strategic priorities and investments. Let's take a look at the few third quarter highlights.
Sales rose 5.6% to a record of $7.9 billion. Organic local currency growth was 5.8% in the quarter, led by safety and graphics at 8%, Health Care at 7% and Industrial at 6%. Our consumer business grew 4% organically as did electronics and energy. This quarter’s organic growth of 5.8% was a significant improvement versus the 2% growth in the first half of 2013. Industrial, safety and graphics, as well as electronics and energy showed the most improvements. On geographic basis, developed economies such as United States, West Europe and Japan also showed substantial improvements.
On a year-to-year basis, we posted positive organic growth in all geographical regions. Latin America, Canada led a way with double-digit organic growth of 11%, Asia-Pacific rose 7%, the United States were up 5% and Europe, Middle East, Africa increased 4%. As expected currency was the headwind to sales, reducing worldwide sales by 1.7% and acquisitions added 1.5 points to third quarter growth. So all-in-all, a very strong quarter with organic local currency growth of 4% across all developed markets and 10% in developing markets.
Operating margins were again strong at 22% or 22.4% excluding the first year impact of acquisitions. All five business groups delivered margins above 20% while also growing their top lines through a continued broad based effectiveness and efficiency. Earnings were $1.78 per share up nearly 8% versus third quarter 2012. Finally, we’ve returned $2 billion to shareholders in the quarter through dividends and share repurchases or $4.8 billion through nine months of the year.
In summary, it was an excellent quarter for 3M on many fronts and our business is continued to grow very profitably. I thank the 3M team for their outstanding effort to deliver these very good results. Let me now review the outlook, please turn to Slide number 5. With one quarter remaining in the year and the business performing to all the expectations, we are narrowing our full-year guidance to $6.65 to $6.75, this is a previous range of $6.60 to $6.85 per share. On organic local currency growth, we’re also narrowing the full-year 2013 range to 3% to 4% versus a pervious expectation of 2% to 5%. We continue to expect that currency impact would reduce sales for the year by approximately 2%, and we look for acquisitions to add about 1.5% to sales for the year.
As for the 2013 tax rate, we now anticipate the range of 28.0% to 28.5%, and free cash flow conversion is expected to be approximately 90%. Now Dave will be taking you through the details of the quarter, David.
Thank you, Inge. Let’s begin with the review of sales growth, please to Slide 6. Organic local currency growth was 5.8% in the third quarter, which was a significant acceleration versus the 2% we saw in the first half of the year. Volumes contributed 4.8% to third growth and we continued to see good pricing power with selling prices up a 4 percentage point year-on-year.
Acquisitions added 1.5 points to sales growth in the quarter, related to Ceradyne in our industrial business and FSTech in safety and graphics. Foreign exchange impacts reduced sales by 1.7% points in the third 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.
Third quarter, sales rose 5.6% in dollar terms. Looking across geographic regions, Latin America, Canada led the way with strong organic local-currency growth of 10.5% in the quarter. All five business groups contributed to growth in the quarter, including double-digit organic growth in Industrial, Healthcare and Safety and Graphics.
Asia Pacific grew nearly 7% organically in the quarter. China, Hong Kong grew by 11% in Q3 with notable strength in Safety and Graphics and in Healthcare, followed by electronics and energy. Organic local-currency growth was 5% in Japan, led by Industrial, Healthcare and Consumer. Organic local-currency growth was 4.5% in the United States, Healthcare, Industrial and Safety and Graphics led U.S. growth in the third quarter.
In EMEA, organic local-currency sales growth was 4.3%. West Europe was up 3%, year-on-year, continuing a positive trend. This was our strongest growth in West Europe since the first quarter of 2011. Middle East, Africa increased double digits and Central and Eastern Europe also posted good growth in the quarter. Organic local-currency growth was 4%, across all developed markets, a positive step up versus recent quarters and 10% in developing markets.
Let’s turn to Slide #7 for a discussion of the third quarter income statement. Sales rose 5.6% to $7.9 billion, which is the highest quarterly sales result in 3M’s history. We generated $3.8 billion in gross profit and gross margins increased 10 basis points year-on-year to 47.6%.
SG&A and R&D investments rose 8% and 6% respectively. Operating income increased 3.6% in Q3 to $1.7 billion. GAAP operating margins were 22%, down 40 basis points year-on-year. Included in these results was a 40 basis point impact from acquisitions, therefore underlying margins were equal to last year’s third quarter result.
Leverage on organic volume growth added 40 basis points to operating margins in the third quarter and the combination of lower raw material costs and higher selling prices added 1.2 percentage points. Strategic investments and one-time actions reduced margins by 80 basis points year-on-year. This represents incremental investments in disruptive R&D, our ERP system and restructuring actions.
Foreign exchange impacts reduced margins by 30 basis points and the combination of the U.S. medical device tax and other factors negatively impacted margins by 50 basis points year-on-year. Third-quarter earnings increased 8% to $1.78 per share. Foreign exchange impacts hurt EPS by $0.04 versus the third quarter of 2012 and a lower tax rate added $0.02. Average diluted shares outstanding declined 2% year-on-year, which added $0.03 to EPS.
Now, let’s turn to cash flow. Turn to Slide #8. We generated $1.2 billion of operating cash flow in the third quarter. Working capital investments were higher year-on-year, largely timing related and we will expect that they will reverse in the fourth quarter.
Capital expenditures were $404 million, an increase of $46 million versus last year's third quarter and we expect full-year CapEx will be in the range of $1.6 billion to $1.7 billion. Free cash flow was $747 million and we converted 61% of net income for the quarter.
For the full year, we anticipate free cash flow conversion will be around 90%. We paid $431 million in cash dividends during the quarter or $1.3 billion year-to-date.
If you look at our balance sheet in today’s press release, you would see that the worldwide cash and marketable securities are $1.6 billion lower today than one year ago. We’re managing the business with lower cash levels, the US in particular for several reasons. First, the business continues to grow and generate significant cash flow. Second rising interest rates are positively impacting our already well-funded pension status and finally our capital structure remains very strong, which is an important component of our business model, but we do not intend to strengthen it further. Gross share repurchases during the quarter were $1.5 billion and for the reason cited above, we’re increasing our expected range to $4.5 billion to $5 billion versus a previous range of $3.5 billion to $4.5 billion for the year. And as Matt mentioned, we’ll provide a full planning update at our upcoming Investor Meeting in December including capital structure and capital allocation.
Now let’s review our third quarter performance on a business-by-business basis. Please go to Slide number nine. Our industrial business had a good third quarter with sales up $2.7 billion and 6.2% organic local currency growth. The growth was broad based as all operating divisions and all geographies posted positive growth. Our aerospace and automotive OEM businesses generated double digit organic local currency growth and we also saw strong growth in advanced materials, liquid filtration, automotive aftermarket and industrial and adhesives and tapes.
On a geographic basis, organic local currency sales rose 13% in Latin America Canada, 8% in EMEA, 6% in the US and 3% in Asia Pacific. The Ceradyne acquisition added 4.1% to growth in the quarter. Integration is going very well and profits continue to exceed our expectations. Nine different 3M divisions have launched development projects that leverage Ceradyne Technology. First year’s sales are a bit short of plan due to US troop draw down efforts, but we’re winning new business with customers. In September for example, we earned an $80 million contract to supply enhanced combat helmets for the U.S. Marine Corps.
Third quarter operating income was $568 million and reported margins were 21.3%. Excluding Ceradyne, industrial operating margins were 22.2%. Margins were also impacted by negative FX and strategic investments in growth programs and our ERP system. Please turn to Slide number ten.
As expected, our electronics and energy business rebounded nicely in the third quarter compared to the first half of the year. Sales were $1.4 billion up 4% in organic local currency terms and operating income rose 3% to $300 million. Margins were 20.7% up a bit versus last year’s third quarter and up 3 percentage points sequentially. Electronics related sales increased 4% on an organic local currency basis. Market demand was stronger year-on-year and we’re expecting to a number of newly introduced electronic devices. Most industry sources are projecting flat demand for electronics this holiday season. As a result we’re planning conservatively through year end.
On the energy side, organic local currency growth was 3%. Electrical markets led the growth, boosted by record sales of our ACCR overhead power conductor. Communications and renewable energy were both slightly positive year-on-year. On a geographic basis organic local currency sales increased 6% in Asia Pacific, 3% in Latin America, Canada and just slightly in EMEA. Organic sales declined 1% in the U.S. Please go to Slide 11.
We saw our growth accelerate in safety and graphics in the third quarter. Sales were $1.4 billion up 8% organically, a significant increase from the 2% in the first half of the year. We generated double-digit organic growth in personal safety products and in roofing granules.
Our Commercial Graphics and Building and Commercial Service businesses also posted good organic growth in the quarter and traffic Safety and Security rose slightly. Sales in Safety and Graphics grew organically in all major geographic regions with strong double-digit growth in both Asia-Pacific and Latin America/Canada.
The FSTech acquisition added 0.9% to growth in the quarter. Safety and Graphics generated an operating income of $315 million, an increase of 7% versus last year’s third quarter. Margins were up slightly year-on-year to 21.8%, excluding FSTech third quarter 2013 operating margins were 22.1%.
Now let’s look at Health Care found on slide 12. Sales in this business were $1.3 billion, up 7% in organic local-currency terms. As was the case in Industrial, we generated positive organic sales growth in every division and in every geographic region within healthcare. Organic sales growth was strongest in food safety, health information systems, oral care, drug delivery and critical and chronic care.
On a geographic basis, organic local-currency sales increased 11% in Latin America/Canada, 9% in Asia-Pacific, 6% in the U.S. and 5% in EMEA. And across all of the developing markets Health Care generated 14% organic sales growth. This is very similar to recent quarters.
Operating income was $426 million, up 7% year-on-year and margins rose 40 basis points to 32.1%. Margins were helped this quarter by a gain on the sale of a small non-strategic asset, offset in part by the U.S. Medical Device Tax, the net of which added 1 percentage point of margin.
Our Health Care business continues to post strong and consistent sales growth and excellent profitability. This helps stabilize the more cyclical elements of our portfolio, the business generates tremendous value for 3M.
Finally, let’s review the Consumer business found on slide #13. Consumer also posted a strong third quarter with sales of $1.2 billion and organic local-currency growth of 4%. Operating income was $247 million, up slightly year-on-year and operating margins were 21.5%. Organic sales growth was strongest in our consumer health care, home care, stationery and office supplies and DIY businesses.
On a geographic basis, organic local-currency sales growth was 9% in Latin America/Canada, 7% in Asia-Pacific, while EMEA increased just slightly. Organic growth was 3% in the U.S. helped by a good back-to-school season. Developing markets within consumer grew 10% organically in the third quarter. Similar to Health Care, the Consumer business is a very steady grower with excellent profitability and is a stabilizing force within the 3M portfolio.
That concludes our discussion of 3M’s detailed third quarter results. I’ll now turn the call back over to Inge.
Thank you, David. Before we take your questions, I want to highlight our progress on three important strategic levers, portfolio management, investment in innovation and business transformation. First portfolio management, we continue to strengthen and prioritize our portfolio. The Electronics and Energy business is a good example of where we are making progress.
In the third quarter we consolidated the Infrastructure Protection Division in to the Electrical Markets Division. Given this business a lower cost structure, improved market relevance and greater in financial reach.
Also, earlier this year, we integrated touch systems into the Electronics Solutions Division to align these businesses to better serve our customers. There is more portfolio work to be done here and we've continued to look at other structural opportunities. One of the primary reasons performing the electronic and energy business was to present a single 3M voice to the electronics industry. Now we are easier to work with and more relevant to launch fast moving electronics customers. And I’m happy to report that we are receiving very positive reaction from customers on all these changes.
Second level; investment in innovation. Innovation remains the center of our plan and as I hope you remember last quarter we shared some details about how we are investing in long term disruptive technologies with significant growth potential. We are now finding 20 new product platforms several of which are expected to be introduced to the market in 2014.
We are also investing in a new state-of-the-art laboratory facility at our headquarters in St. Paul Minnesota, which I announced last year. We broke ground in August and construction is well underway. This new laboratory will be an important part for 3M's global research network.
Finally the third level, we continue to make good progress with respect to business transformation and ERP implementation. We successfully went live in Taiwan, Russia, Indonesia and Philippines and in October we went live in Canada. Next up is our European Middle-East Africa supply chain center of excellence in Switzerland in November. Twenty more countries are scheduled for 2014. We expect to achieve benefits in many areas including supply chain, working capital management, customer responsiveness, improved business planning and faster decision making.
In closing, we deliver strong third quarter with good broad based performance across all business. We remain focused on expanding our business driving productivity and executing a plan with strong discipline. I thank you for your attention and we will now take your questions and comments.
Earnings Call Part 2: