3M Company

Ladies and gentlemen, thank you for standing by. Ladies and gentlemen, thank you for standing by. Welcome to the 3M First Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a -and-answer session. At that time, if you have a question, please press the one followed by the four on your telephone keypad. 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, April 25th, 2019. I would now like to turn the call over to Bruce Jermiland, Vice President of Investor Relations at 3M.

Thank you and good morning, everyone. Welcome to our First Quarter 2019 Business Review. With me today are Mike Roman, 3M's Chief Executive Officer, and Nick Gangsted, our Chief Financial Officer. Mike and Nick will make some formal comments and then we'll 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 two. Before we begin, let me remind you to mark your calendars for our upcoming earnings calls on July 25th and October 24th. Please take a moment to read the forward-looking statement on slide 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, 10K, lists some of the most important risk factors that could cause actual results to differ from our predictions. Finally, please note that throughout today's presentation, we will be making references to certain non-GAAP financial measures. In particular, measures which exclude the impact of the Tax Cut and Jobs Act and significant litigation-related charges. Reconciliation of the non-GAAP measures can be found in the appendix of today's presentation and press release. Please turn to slide four, and I'll hand it off to Mike. Mike? Thank you, Bruce.

Good morning, everyone, and thank you for joining us. The first quarter was a disappointing start to the year for 3M. We continue to face slowing in several key end markets which impacted both growth and margins, and our operational execution fell short of the expectations we have for ourselves. Today, I will lay out a number of aggressive actions we are taking to drive productivity, reduce costs, and improve cash flow as we manage through challenges in some of our end markets. In addition, I will provide an update on two litigation issues that affected our results, and provide updated guidance for the full year. I will also discuss the realignment of our business groups that we announced last month, which will enable even greater growth and operational efficiency. Please turn to slide five for a summary of our first quarter numbers. Organic growth company-wide was minus 1% lower than we anticipated. We saw end market softness in China, automotive, and electronics, which we have discussed throughout the quarter. We also faced channel inventory adjustments which negatively impacted several of our businesses. With respect to EPS, we posted adjusted earnings of $2.23 per share, down 11% year over year. This excludes significant litigation charges related to PFAS and respirators, which I will discuss later in my remarks. Underlying margins were 21% in the quarter, down 160 basis points, with adjusted income of $1.7 billion. Our earnings and margin shortfall was due to a combination of two things. First, negative organic growth in the quarter, and second, weak productivity, especially in our industrial-related businesses within Asia Pacific and the United States. As the actions we took were not sufficient to offset the broad-based softening we faced in those markets as the quarter progressed. Please turn to slide six. We are moving quickly to strengthen our performance and address the challenges we face, and the actions on this slide are underway. First, we are reducing approximately 2,000 positions through both voluntary and involuntary actions. Reductions will span all business groups, functions, and geographies, with emphasis on corporate structure and underperforming areas of the portfolio. On a pre-tax basis, we will take a charge of approximately $150 million in 2019, and we expect annual savings of approximately $225 to $250 million, with $100 million this year. Job reductions are never easy, but they are necessary to make us stronger and a more competitive enterprise as we move forward. Beyond restructuring, we are also driving cash flow by reducing inventory levels and accelerating actions on indirect costs. Importantly, while we take these actions, we remain focused on our customers and balancing short-term pressures with the long-term success of 3M. That is why we will continue our investments in growth, which includes research and development and our priority growth programs. This is a playbook we know how to execute, and we are confident it will enable us to maximize value for shareholders as we work through the market slowdowns and our related actions, positioning us for strong growth as our markets recover. Please turn to slide seven. As I mentioned earlier, two significant litigation matters related to PFAS and respirators impacted our quarter and resulted in a total charge of $548 million, or 72 cents per share. We increased our respiratory reserve by $313 million to address the cost of resolving all current and expected coal mine dust lawsuits in Kentucky and West Virginia. We also established a PFAS reserve of $235 million to cover certain environmental matters and litigation related to the manufacture and disposal of PFAS at five 3M facilities, including three in the United States and two in Europe. This reserve does not include any product claims related to PFAS. We continue to work closely with the EPA and other regulatory bodies to support science-based regulations of these chemistries. We also continue to work with the communities we serve to ensure they can have confidence in the quality of their drinking water. Additional details will be available in our upcoming 10Q filing. Please turn to slide eight for an update on our 2019 guidance. While we remain positive on the global macroeconomic environment, growth conditions in certain markets have been slower than anticipated going into the year. As a result, today we are updating our range for organic growth to minus one to plus 2%. Against the prior range of one to 4%. In addition, we anticipate adjusted earnings of $9.25 to $9.75 per share, which includes the restructuring impact versus the previous range of $10.45 to $10.90. We now expect a return on invested capital of 20 to 22% against the prior range of 22 to 25%. We continue to anticipate a free cash flow conversion rate of 95 to 105%. I'll come back to make some comments on our new business group alignment after Nick takes you through the details of the quarter.

Nick.

Thank you, Mike, and good morning, everyone. Please turn to slide nine. Organic sales declined .1% in the first quarter, with volumes down 200 basis points, and selling prices up 90 basis points. The net impact of acquisitions and divestitures reduced sales by 50 basis points, while foreign currency translation was an additional 3.4 percentage point headwind to sales. All in, first quarter sales in U.S. dollars decreased 5% versus last year. Geographically, the U.S. declined 40 basis points organically. Consumer and electronics and energy grew low single digits, while industrial, safety and graphics, and healthcare declined. Asia Pacific was down .6% organically in Q1, impacted by the slowdown in China, automotive, and electronics markets. Healthcare delivered positive high single digit organic growth in the quarter, while industrial, consumer, and electronics and energy declined. Organic growth was down 4% in China, Hong Kong, against an 11% comparison a year ago. Japan organic growth declined 7%, or excluding electronics increased 2%. Latin America, Canada, and EMEA each grew 1% organically in the quarter. Please turn to slide 10 for the first quarter P&L highlights. Companywide, first quarter sales were $7.9 billion, with adjusted operating income of $1.7 billion and adjusted operating margins of 21.4%. On the right hand side of this slide, you can see the components of our margin performance in the first quarter. Declines in organic volume and weak productivity reduced margins 180 basis points year on year. Productivity challenges were most pronounced in our industrial related businesses within Asia Pacific and the United States. Acquisitions and divestitures combined brought down margins by 40 basis points, primarily driven by our acquisition of M-Model, which closed in February. Higher selling prices continued to more than offset raw material inflation, contributing 30 basis points to first quarter margins. And finally, foreign currency net of hedging impacts increased margins by an additional 30 basis points. Let's now turn to slide 11 for a closer look at earnings per share. First quarter adjusted earnings were $2.23 per share, down 11% year over year. As you see, a number of factors impacted first quarter earnings. Most significantly, negative organic growth and weak productivity reduced per share earnings by 19 cents in the quarter. This was notably different from our outlook in January. The rest of our EPS factors are in line with our original expectations. Acquisitions and divestitures combined reduced first quarter earnings by seven cents per share versus last year. Foreign currency net of hedging was an additional five cents per share headwind in the quarter. As expected, our underlying tax rate increased year on year, which reduced Q1 earnings five cents. And finally, we reduced average diluted shares outstanding 4% versus Q1 last year, adding nine cents to per share earnings. Please turn to slide 12 for a look at our cashflow performance. First quarter free cashflow with $657 million with a free cashflow conversion rate of 74%, which includes a 24 percentage point benefit from the litigation related charges. First quarter capital expenditures were $391 million, up $87 million year on year. For the full year, we now anticipate CapEx investments in the range of $1.6 to $1.7 billion versus a prior range of $1.7 to $1.9 billion. We increased our first quarter per share dividend by 6%, resulting in $830 million in cash dividends paid to shareholders during the quarter. Gross share repurchases were $701 million in the quarter, and we continue to expect full year repurchases in the range of two to $4 billion. Please turn to slide 13, where I will summarize the business group performance for Q1. Please note additional business group performance details can be found in the appendix of this presentation. As mentioned earlier, throughout the quarter, we continue to see soft and market trends in China, automotive and electronics, along with channel inventory adjustments. These trends primarily impacted our industrial, safety and graphics, and electronics and energy businesses. Our industrial business saw a broad-based slowdown across most of its portfolio, posting an organic sales decline of .8% to start the year. The slow organic growth within industrial was most pronounced in our automotive business. Our automotive OEM business was down 9% year on year, impacted by a 6% decline in first quarter global car and light truck builds, along with channel inventory reductions, particularly in China. A positive note, advanced materials continued to deliver strong organic growth in the quarter, up high single digits. On a geographic basis, industrial's organic growth was led by 1% increases in both Latin America, Canada, and EMEA. While the US declined 2%, and Asia Pacific declined 8%. Industrial's first quarter operating margins were 20%, down 280 basis points, impacted by sales declines and weak productivity. Moving to safety and graphics, first quarter sales were flat organically against last year's 7% comparison. Personal safety continued to deliver solid results in Q1, up 3% organically, while each of the other three businesses declined. Geographically, organic growth was led by Latin America, Canada, and EMEA, each up 2%. Asia Pacific was flat, while the US was down 3%. Safety and graphics first quarter operating margins were 23.2%, down 380 basis points. The year on year operating margin decline included a negative 110 basis point impact from a gain on the divestiture last year, along with slow growth and weak productivity. Next, our healthcare business was up 1% organically in the first quarter. Holding back growth in healthcare was the continued softness in our drug delivery business, down nearly 20% organically in the first quarter, which negatively impacted overall healthcare organic growth by nearly two percentage points. Organic growth was led by food safety, up high single digits, followed by health information systems, up mid single digits, while medical solutions and oral care were each up low single digits organically. On a geographic basis, Asia Pacific led the way up 7%, with EMEA up 3%. The US declined 3% impacted by drug delivery. Healthcare's first quarter operating margins were 28.1%, which included a negative 230 basis point impact from the Q1 acquisition of Imodal. Shifting to the electronics and energy business, organic sales declined 3% in the first quarter. The energy side of the business grew 5%, while the electronics related businesses were down 6%, with declines in both display material systems and electronics material solutions. Electronics related growth was impacted by soft and market demand in consumer electronics and factory automation, along with channel inventory adjustments. On a geographic basis, organic growth was led by a 2% increase in the US, while Asia Pacific declined 5%. First quarter operating margins were 23.8%, down 110 basis points year over year. Lastly, first quarter organic growth for the consumer business was 1%. Sales grew in our home improvement business, up 3% organically, while home care and consumer healthcare declined. Looking at consumer geographically, organic growth was led by a 3% increase in the US, with particular strength in our filtrate and command brands. EMEA declined 1% as we continue to adjust our portfolio in this region, and Asia Pacific declined 3%, impacted by lower consumer demand for respiratory solutions. Consumers operating margins were .5% in the first quarter. That wraps up our review of first quarter results. Please turn to slide 14, and I'll hand it back over to Mike to discuss the business group realignment. Mike? Thank you, Nick.

Earlier, I laid out actions we are taking to address our near-term challenges. At the same time, we are continuing to build 3M for the long run. Effective April 1st, we moved from five to four business groups in order to better serve our customers and better align our businesses to their markets. The new business groups are organized around customers and -to-market models, and include safety and industrial, transportation and electronics, healthcare and consumer. This realignment will enable us to accelerate growth, maximize value across the portfolio, and take greater advantage of our transformation progress. It will also further streamline the organization and help us achieve the 200 to 300 basis points of margin expansion that we laid out last November as part of our five-year plan. We will start reporting results under this structure in the second quarter. Please turn to slide 15, and I will take you through our 2019 guidance for the new business groups. We expect organic growth to be led by healthcare with a range of two to 4%, followed by consumer at one to 3%. Organic growth in safety and industrial is expected in the range of minus one to plus 2%, with transportation and electronics at minus three to flat. That wraps up our prepared remarks. In summary, while our recent performance is disappointing, our business model remains strong, and we are making the necessary changes to accelerate 3M into a stronger future. Thank you, and we will now take your questions.

Ladies and gentlemen, if you would like to register a question using a landline phone, please press the one followed by the four on your telephone keypad. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift your handset before entering your request. Please limit your participation to one question and one follow-up. One moment, please, while we compile the Q&A roster. And our first question comes from the line of Andrew Obin of Bank of America. Please proceed with your question.

Good morning, guys. Morning, Andrew. Just a question on margins. I think the last time you had this kind of revenue decline, as I look at my model, was sort of 4Q15, and 1Q16. And sort of the operating leverage impact was a lot less, I think, in 1Q16 margins actually went up. So I'm just trying to understand what happened with the margin decline in the quarter, and specifically also as I look at the gross margin, what surprised me, once again, looking at my model, the last time you had gross margin that low, I think was 4Q08 or 1Q09. So that's very odd. Thank you.

Yeah, thank you, Andrew. Maybe I'll start and I'll ask Nick to give some more detailed comments. You know, the two drivers of that, one is the organic growth. And the organic growth, as we talked about, was led by China Automotive and Electronics, which are strong gross margin businesses for us globally. So that was one of the contributing factors. And then the adjustments that came in the channel, along with that slowing growth in those markets, you know, that drove challenges for us in productivity in the plants. And we took actions to adjust our production levels and our costs there, but we didn't get ahead of it. So those were a couple of the big contributors really driven off of that, those slowing, the majority of that slowing from those men in markets.

Yeah, Andrew, a couple of things to add in there. As we were going through the quarter and seeing lower volumes, we of course adjusted the output coming out of our factories. So for the first quarter compared to the first quarter last year, we were seeing the output in our factories down between four and 5%. Unfortunately, we did not pull spending down proportionately. Our spending was down about 1% in our factories during that time. And that had a negative impact on our margin. And also in there was the impact of a bit of a geographic mix. If we look at where we make higher margins and lower margins, the declines that we saw in Asia Pacific had an outsized impact on our margin this quarter.

Andrew, I would also add, as I said in my speech, we didn't respond aggressively enough to what we were seeing. And so we're behind the curve as we came through the quarter. That's why we're stepping in aggressively to the actions that we are.

Let me ask the question maybe another way. What really surprised me, I think the Asia pipeline growth was fairly well telegraphed. Maybe Japan surprised a little bit. But it's North American decline that also surprised me. And you continued sort of, you did note weak productivity in North America multiple times. And I was just wondering how much, and I know we sort of finished the customer facing ERP rollout. Can you just give us an update? Are you rolling out on the factories, your key factories in North America? You're rolling ERP on the manufacturing floor. And is that disruptive? Thank you.

Yeah, Andrew, just to update on the ERP. We've actually been very pleased with the success that we've had in the deployment in the US. And it has been around the businesses and not deployed to the factory level at this point. It's improving every month in our performance and what we can deliver to our customers. So that is, that's been something that's been going well for us. When you look at the US, the organic growth in US was led by industrial business, really the automotive, automotive OEM and aftermarket businesses. There are some pockets in safety and graphics. And so the same kind of comments I had is, as we saw slowing growth and some of the channel reactions, our production levels and our productivity didn't get ahead of it. And that was an important part of what we saw in the US. There's some other pockets, there's some pockets in healthcare with drug delivery in the US that also contributed to that. But that kind of gives you the background in the US.

Thank you.

Our next question comes from the line of Joe Ritchie of Goldman Sachs. Please proceed with your question.

Thanks, good morning everyone. Morning Joe. So I'm just thinking about the organic growth guide for the year of minus one to plus two, obviously slower start towards the low end to start the year. I guess I'm just, as I'm thinking about how you guys actually get towards that higher end of the range as we progress through the year, I'm just curious, like, did trends get any better as we exited the quarter? I know comps get tougher as we progress through the year. I'm just trying to like put some context around that guidance for the year.

Yep, yep. So Joe, maybe I'll start. It was led by the markets that we called out and the channel reaction to some of that, that doesn't end up being an all year reaction. That is something that happens pretty quickly. So we don't see that necessarily being a contributor as we go through the year. And we do see some outlook for improvements in those markets. Healthcare, we have talked about the challenge we see with drug delivery being a headwind for us in the first half of the year, and that gets better as we go through the year. Consumers basically at the bottom end of their range and the sellout remains strong. And in safety and graphics, we have a couple of pockets there. Our personal safety business is off to a strong start to the year and so up mid single digits or low to mid single digits. And we expect that to continue. The other pockets are more project delays in particular businesses and we expect those to improve as we go through the year. So it's really taking a look at each of those businesses and the guidance that we gave to those fits with Q1 and then where we see the

rest of the year. And Joe, on the comp issue, consistent with what we've been saying, we see second quarter as our toughest comp and third quarter as our easiest comp. And that's primarily driven by what we had talked about a year ago as far as the timing of revenue related to our US ERP go live. So we saw almost 6% organic growth in second quarter last year, followed by .3% in the third quarter. So those are the two where we see the comps differentiating. All in, we saw and we continue to see the first half as a slightly tougher comp for us than the second half of the year.

Okay, got it, that's helpful. And if I could just kind of follow up just on the margins for a second. So in taking a look at your gross margins for the quarter, it's hard for me to go back into history and see a time where gross margins were down as much year over year. And Nick, you referred to it a little bit when you respond into the lower growth environment and your response from a cost out perspective at the factory level. I just wanna understand that a little bit better because historically this hasn't been part of the hallmark of how you guys have executed.

Yeah, Joe, just one thing I think I need to make sure is clear with you and with everyone. In the gross margin on a gap basis is $235 million charge related to PFAS. So in the numbers that you're seeing there on our gap results, not all of that hit SGNA, other 235 of that is recorded in gross margin and Andrew, that may go back to your earlier question too. So that's maybe when you're looking at our gap results that one thing you're seeing. That said, we still saw declines in our gross margin percentage primarily driven by what I just talked about of the lower volumes not offset with commensurate declines in spending. Pulling out the PFAS charge, we saw our underlying gross margin decline about 100 basis points. Okay, thanks for that clarification.

Our next question comes from the line of Andrew Kapowicz of Citi. Please proceed with your question.

Hey, good morning, guys. Morning, Andy. Mike and Nick, you mentioned productivity is a big issue in industrial in North America and Asia Pacific. If we go back over time, industrial has been a segment where 3M has consistently struggled to grow margin and obviously productivity we just talked about was worse than Q1. So could you talk about the new transformation helping North America? I know you mentioned it's helping, but it's hard to see. And then can you talk about your confidence that you can improve productivity in the quarters, especially North American in Europe, where you've talked about an expectation of big margin improvement going forward?

Yeah, so Andy, when you look at industrial, there's a couple of things around productivity that we're focused on. And the first one is getting in line with the growth that we see in the business. And automotive OEM, automotive aftermarket, those are challenged end markets that we're especially aggressive getting on top of in terms of our productivity. But it's more broad than that because especially in the US, we are a net exporter out of the US and we do support business around the world in particular in Asia. And so we're impacted by a broader softness in those markets as well. So it's a bigger productivity challenge in particular in the US, but in industrial more broadly. And so the actions that we're focused on, they're targeting that, getting ahead of the curve, so to speak. And then it's taking advantage of all the other things that we've talked about, the levers for creating greater value and business transformation is a big one of those. Now we haven't deployed that in the US into the plans, but we've made good progress with the Go Live, since the Go Live of last year. And we continue to say good benefits and value coming out of the ERP deployment in Canada and in EMEA. And our margins more broadly, including industrial have been improving there. And in part because of what we're doing in business transformation. So that's gonna be an important lever as we move ahead. But the near term is getting ahead of the impact of the slowing end markets and the channel and getting our productivity in line.

Okay, Mike, and maybe shifting gears, can you talk about the cadence of your business performance through the quarter and what you've seen to the extent that you can talk about in April? There obviously has been more enthusiasm in places like China, given increased stimulus and our tax cuts that could help markets like China Auto or electronics. So have you seen any improvement in any of your short cycle businesses over the last few weeks or month or two?

Yeah, Andy, certainly as we went through first quarter, you know, we talked a bit about the slowing that we saw as we went through the quarter. And that continued right through the end of the quarter and really led by those markets, China Automotive, Electronics. So those are all the ones we've been talking about. You know, there is, I think the outlook is that gets better. You know, when you listen to, you know, the projections and the economic projections in those areas, you know, we haven't seen that. April is basically on track with what we're laying out for our total year guidance. But, you know, seeing a market improvement in those markets, I think we'll see, we'll get an answer as we move further into the quarter, into the second quarter.

Thanks, guys.

Thanks,

Andy.

Our next question comes from the line of John Inch, Gordon Haskett, please proceed with your question. Oh, thank you. Good morning,

everybody.

Morning,

guys. Mike, you opened the call talking about you sort of were positive or remain positive on the global macro. But I'm trying to understand, maybe back to Andy's question, there is a degree of evidence, right? That electronics markets in Asia, maybe even China and China Auto and so forth are bottoming. Why would you take the 2000 heads action now? I mean, are you implicitly signaling that you actually don't think that there's going to be much of an improvement in the foreseeable future, or, you know, is this kind of a catch up from stuff that you should have been doing before and you were just more hopeful things were not gonna kind of fall apart to the degree they have?

Yeah, John, so, you know, your point about the global macro is right. There is an expectation that there'll be a broader growth in the global macro and maybe a bit slower as we come through the year in terms of global industrial production in particular. And the markets that we're talking about, they certainly have been slower, but, you know, people have a view that it gets better as we get into the second half. You know, I think to a degree, it's realigning ourselves. The actions we're taking is realigning ourselves with what we see in the market and what we've been working through as we've come through, for sure, kind of the end of Q4, into Q1. If the markets recover, you know, we, you know, this is our playbook. When we see a slowdown, we, you know, we realign our costs, we realign our operations, we take some targeted restructuring actions, and then we're in a good position to lead out. So I think this aligns us with what we see today, you know, really what we need to do in order to deliver on our commitments, and then positions us to lead out of it. And so if we do see that improvement in the second half, we'll be well positioned to lead out, even with these actions that we're taking.

In other words, you don't have to hire people back if things turn, is that what

you're saying? No, I think we're aligning ourselves as we go forward, taking advantage of, you know, some of the things that we're doing to, you know, with business transformation, to leverage that. So, you know, this is, it's never easy to do this. And it is, you know, you're asking a question around something that we think very hard about. And I really am taking on very personally, we've got to think about what do we need to do near term and position ourselves for the long term. And we're going to continue to invest in growth, into R&D and priority growth programs and priority growth opportunities more broadly. So we're making sure to make this restructuring and realignment targeted to what we have to manage through. And so, you know, will we need to hire people in the future? Yes, of course, as we go forward, where we see the opportunities and we'll invest. But in the near term, we've got to realign ourselves to be ready to deliver on those commitments.

Got it. I want to shift gears to PFAS. If you go by the K, the litigation over the past couple of years definitely seems to be rising. There's a lot of reasons that people have potentially thrown out. First, I want to confirm that you do not have insurance in any context to, you know, pay for any of these litigation costs. I think the 850 to Minnesota was paid out of cash, right? And then the second thing is, could you guys just give us a sense of what exactly is your playbook for dealing with this? Are you just going to kind of litigate, you know, concurrently or are you going to try and bundle this and deal with it? I just, it's hard to know from where we stand, right? Why this isn't potentially sort of an asbestos round two that, you know, unfortunately ended up bankrupting dozens of US companies. And I don't think you're in that situation, but anything you could say to that would be helpful.

Hey, John, I'll just start talking about insurance and then I'll pass it over to Mike for your broader question. In regards to insurance and coverage for that for environmental claims such as PFAS, we do have places where we think we have insurance coverage and we are in discussions with the insurance carriers regarding those matters, but that's going to take time for that to play out, John. Don't look for that in the short term for something to happen on that front.

Yeah, John, just regarding the litigation activity, I mean, we are actively defending ourselves in all of this litigation and it's difficult to know, you know, the timing and outcome of any particular litigation and what we were able to do with the reserve this quarter is to really, you know, really establish reserves that help us resolve the litigation that is related to environmental matters and I would say litigation, we're the direct defendant around our manufacturing and disposal. As I said in my comments, it is not covering any of the product-related PFAS litigation and we have the manufacturing in view where it's probable and estimable. The product litigation at this point that we're defending ourselves against is not probable and estimable and so we will update as appropriate and as we get some clarity on that. So, you know, it's really, you know, there are two different aspects of it there that we're managing.

This is, it would be fair to say, this has gone on for years. I don't see any sort of a milestone event that potentially stops it. Is that a fair thing? It looks like the EPA is going to potentially come out with even more particulate, you know, regulations or guidelines or something like that.

Yeah, we continue to work with the EPA and other regulatory bodies on the foundation for the regulations that are being talked about and what will come. EPA, of course, announced a management plan for this and we're working with them, you know, to support where we go forward there. We actually are supportive of a federal approach here so we don't end up with, you know, state by state approach that's different or a patchwork kind of approach. But it is something that is evolving and we'll continue to, you know, help be part of that with the EPA and, like I said, we'll update you on our litigation matters as appropriate.

Got it, thanks very much,

appreciate it. Our next question comes from the line of Julian Mitchell of Barclays. Please proceed with the question.

Hi, good morning. Morning,

Julian.

Morning. Maybe a first question for Mike. So just trying to think about, you know, the last few months at 3M, you had the Outlook meeting in November with some medium term goals. Then you had a sort of resegmentation more recently and then today a restructuring alongside another guidance reduction. So I understand that the restructuring and the guidance reduction obviously very closely linked. But I'm trying to understand, you know, what else has changed since that November meeting where it sounded like a case of, you know, steady state, high CAPEX, high R&D, the same segments. Then we heard the segments being changed. Now the CAPEX commitment seems to be wavering per the CAPEX cut this morning. So maybe just talk us through more broadly, you know, how your own thoughts about running and organizing and managing 3M have changed in the past few months.

Sure. And I'll go back to that in November investor day. I would say, first of all, the realignment of the business groups was part of our thinking at that point. We weren't ready to announce it and implement it. There were things that we had to do to get ready for that. But it was part of, even as I talked about, it's part of our expectation that will drive improvements of 200 to 300 basis points in our margin. And it really is, you know, set up to help us leverage best our business transformation and end to end streamline our connection to customers. So it's part of the longer term strategy. As we came into the year, as we walked through the quarter, even as we came in, we certainly acknowledged that we were seeing slowing in some of those PN markets. It got more severe as we got to our earnings call in the Q4 earnings call in January. As we went through February, we saw additional slowing and we're talking about it. And we were taking actions all along the way. We were doing things. We've been doing things along the way to adjust and address that slowing we were seeing, but we didn't get ahead of the curve. And so the restructuring and the other actions we're taking is to really do that now. So it is, I would say it's still rooted in that five-year plan and our commitment to investments and growth and R&D and the strategies that we talked about there is still very much part of it. The 3M model is strong. We've got to near term execute and get in line with what we're seeing in these end markets. And that became kind of the new, I would say set of actions that we had to step into and we're doing that. But again, we know how to execute this playbook. I will be rallying the team around this as we go through the next couple of days. And I'm confident that we will step into it as we go ahead.

That's helpful. And then my second question may be around any updated thoughts on the portfolio. Should we view the resegmentation as opening the door to any divestments? Does the guidance reduction make you think that maybe more portfolio pruning is needed? And on the other side of the ledger, should we expect more acquisitions now that M model has closed? Or is it more of a case of there are some internal things to fix, let's fix those first and think about M&A maybe next year?

Julie, I'd start here as I always do. Organic growth is our first priority. So we're gonna continue to focus investments there, as I said, even as we go through this restructuring. But we still maintain flexibility to invest in the long-term value of the enterprise. And so acquisitions, we have built strong capabilities to make acquisitions that fit with our fundamental strengths that fit in our most attractive markets. And we've been executing that. We still see that as a value driver for us in the future. And so we continue to stay active looking at acquisitions. We're gonna continue to step into compelling acquisitions that leverage that strategy and capabilities that we have to create value. On the divestiture side, we've been actively managing a portfolio since 2012. And over the last three years, we've strengthened parts of our portfolio. It was a case where we're always looking at how do we maximize a portfolio? And we're looking at businesses, regardless of size, on how do we do that? And how do we maximize value for the company? And it's really around the fit with our fundamental strengths and we'll continue to actively manage it as we go forward. It's an ongoing process and we'll be focused on creating value with that as well.

Great, thank you.

Our next question comes from the line of Josh Pokowinski and Morgan Stanley. Please proceed with your question.

Hi, good morning, guys. Hey, Josh. Just on the comment on inventory, de-stocking, Mike, do you have a sense for what that might have cost you in the quarter?

Josh, so for the quarter, we still built inventory I mean,

your customers de-stocking, I'm sorry.

Oh, I'm sorry. I think it very easily could have impacted our total revenue by a hundred basis points.

Josh, just to give you a little color too, the automotive slowdown in China was one particular case where we saw significant impact in our growth from channel. And so where you see a slowdown in a particular market like electronics or automotive, it's accompanied with a change in inventory, everything from finished goods back through the value chain. And so that's clearly visible in those cases.

Got it. And then just pivoting back to an earlier question on some of the PFAS litigation, as a non-attorney, this may be more obvious to other folks than myself, but given that you already have kind of one site example in Minnesota with an 850 settlement, is there a reason why adding the other four in there might not just be 850 times fours or kind of an easily digestible answer or is it a lot of, hey, it depends and there's a lot of differences?

Well, our manufacturer footprint is different in every one of those sites. And so that's part of it, but it really, you know, I guess what you can take from this is it's not simply that, not simple math of multiplying times five. We've, you know, we now define probable and estimable for the litigation that we face in those five sites with this reserve. So that is our, you know, the way we have determined what is estimable across that.

Got it, thanks for that. And then just one last one on some of the resegmentation. You know, I understand this is not quite the same thing as ERP was last year, but could we expect some sort of disruption, you know, to the customer side with some of the restructuring and resegmentation being implemented? Thanks.

Yeah, you know, the realignment of the businesses is really the key focus for us was the customer and really aligning to them, the agreements and the type of customer and the -to-market model. So we are, we're actually, we've been moving towards this with some of the -to-market model capabilities that we've been putting in place and the way we've leveraged business transformation. This actually steps it forward even more. So I think, you know, I think this is not only focused on the customer, I think the customers will see this as a positive step forward and we'll see it as better aligned to them as we, globally, as we move ahead. Okay, thanks Mike.

Our next question comes from the line of Dean Dre of RBC Capital Markets. Please proceed with the question.

Thank you, good morning everyone. Hey Dean. Morning Dean. Hey, I missed the very beginning intro comments and we've touched on this channel inventory adjustment topic a couple different times, you know, with Josh's question just then, but can you just clarify how much was a, any kind of 4Q pull-in, getting ahead of tariffs, getting ahead of price increases and maybe you also had some of this ERP pull-in as well. How much of a factor is that in terms of this inventory adjustment?

Yeah, Dean, if you, you know, we talked about this a bit on our Q4 call. We saw the channels as balanced as we came into the year. We didn't see a pull-ahead from Q1 into Q4. You know, the ERP impacts were largely Q2, Q3. We saw some tail of that into Q4 and it's hard to tell there may be a small tail as we come into this year as well, which would be more playing out of some inventory, but that's a US kind of view. You know, when I look at it, even as we went through the quarter, I would say healthcare channels are well balanced. We certainly saw a balance between sell-in, sell-out and consumer. It was the electronics and automotive driven changes that really led to the channel impact, you know, and maybe a few pockets in safety and graphics in areas like transportation where we had some project delays, but the bigger was in the industrial and electronics areas. So that developed as the quarter went along and the response was, you know, very, very direct and we saw that in Q1.

Got it. And then to go back to your comments about the lag in realigning your costs with the lower demand through the quarter and be interested in hearing from you about what was different about your response time. Is this inherent to 3M short cycle business? You just don't have that visibility, so therefore you can't ramp down the cost structure that quickly. Does that put you at a disadvantage here in terms of the responsiveness? You know, when I look at decrementals, companies that can ramp down costs quickly, typically will see a 25% decremental and you're well lower than that. So it looked like it did get away from you, but some color there would be helpful.

Yeah, Dean, we did take actions as we saw slowing growth. You know, we're reducing production plans, we're adjusting demand plans and we're trying to look ahead as much as we can into our customers, get a clear view. And I would say in the direct businesses, we got a pretty clear view. It was a matter of how fast can we react? And you know, we took actions. In the end, our volume that we produced went down, you know, in line obviously with our organic growth, but our costs didn't and that was one of the challenges. And some of that is fixed cost, some of that is variable costs and we need to do something on both of those. And so that's where the restructuring is targeting that. And that's not unusual in these situations and the industrial slowdown in 2015, 16, I faced the same thing in leading that business and even in 2009, we had to take restructuring actions to really step into a bigger slowdown and those particular markets, that's what it's taking here. And so the steps we took, you know, now we'll get ahead of the curve. Got it, thank you.

Our next question comes from the line of Scott Davis of Mellius Research, please proceed.

Hi, good morning guys. Hey, Scott. I wanna change gears a little bit because I think most people at this point kind of get the issues, but I wanna talk a little bit about R&D productivity and payback because just back of the envelope, I don't think 3M historically has outgrown the industrial group and in fact seem to have undergrown some of the higher end peers out there and certainly spend a lot of money on R&D. Obviously there's a higher margin structure that is supported by that, but how do you fix that, Mike? How do you get the growth rate to you know, really accelerate from these levels which are really basically just GDP type levels that, you know, over time, over really almost any time period you look at?

Yeah, Scott, so you're right. Our investment in R&D and I would say innovation more broadly is fundamental to what we promised our investors and that is strong growth, you know, growth that outgrows the macro over our business cycles and deliver premium margins, deliver premium ROIC and innovation is fundamental to that. In fact, it's the differentiator in our ability to do that and I think it's, you know, in a quarter like this and even the cycle that we've been going through, it's right to challenge our growth aspect of that and what we are doing is really, you know, focused on that as well and I would say this, our capacity and our demonstrated ability to outgrow the macro over time has come from two important factors. One is our investment in innovation, our ability to deliver new penetration opportunities with our innovation, you know, new priority growth platforms as we talk about and so those are very much a focus for us. It's also important that we do that in markets that are accretive to the macro and that we're choosing and that's our portfolio management, make sure we're prioritizing in the most attractive market spaces and so that is what we, you know, we often talk about, you know, the priorities organic growth in our capital allocation, you know, approximately 6% to sales in R&D and, you know, five to five and a half percent in CapEx but we prioritize that. It is really important that we prioritize that and that's what we do to get that growth where we need it to be and we do it in markets that are most attractive and that's the focus. That's when I talk about continuing to invest in growth, that's what I'm talking about.

Fair enough, Mike and, you know, whenever you have, I mean, I know you've been on board now, you know, you're not brand new but you're relatively new, I think in comparison to many CEOs and do you think you need to change the compensation scheme at all or is there something that, you know, as far as getting incentives more aligned with faster execution, you know, because I don't mean this to be mean but if you go back really, I think about the 20 years or so I've covered your stock, Tram always seems to be a little bit behind on the restructuring curve, almost never ahead and even if you get this one right, you're still behind. So do you need to change anything around the incentives or compensation scheme to get some of your leaders to move a little faster?

I think compensation's an important part of this, and we've updated and modified our compensation over time to do just what you're talking about, to really align our leaders with what we need to deliver and in particular, our promise to our investors, you know, our organic growth, our EPS growth, our ROIC, our free cash flow, that is how they're aligned. They're aligned to the four promises and, you know, will we, should we take another look at that? I would say that's a normal course for us. We are, we're gonna take stock of, you know, what we're doing, how we're doing it and compensation's an important piece of it and we'll look at that as well.

Okay,

good luck guys,

thank you.

Our next question comes from the line of Lawrence Alexander of Jeffries. Please proceed with your question.

Good morning, so just wanted to touch on two things. Just wanted to touch on two things. First, is there, as you think about the, when I think about the calls where you talked about the struck down, this kind of frequency, it's usually a multi-quarter episode. I mean, I'm thinking about like the way you flagged the downturn in Latin America a few years ago. Are you, can you just be clear, have you seen any actual turn in your order patterns or is it just at that sequential stabilization?

Lawrence, I mean, you broke up a bit, so I'm not sure I got the question, but I think you're asking about, you know, the softening and the slowdowns that we're seeing, they can sometimes last longer. Do we see any indication that those are turning or not expected to last longer? Is that kind of a basis of- Right, right,

have you seen any sort of actual turn in order patterns or is it really just more because everybody's forecasting the back half therefore?

Well, I would say we haven't seen a sharp turn in the softened markets. You know, we're in line as we go into April with our expectations. You know, I would say maybe we see the inventory adjustments slowing down. I mean, those tend to be, those don't tend to be four quarter unless there's another macro kind of event that drives it. Those will adapt pretty quickly. You know, and we're seeing, you know, maybe some signs of that as we go forward, but we certainly don't see what these particular markets, automotive, electronics, they're forecasting a stronger second half and we don't see the early indication of that yet. You know, I think it makes sense to a degree what they're talking about, but you know, not early days of April have we seen that.

And then just secondly, on the litigation side, how much have you, have you done a full scrub of the exposures? Because I mean, when you have a scientific, a culture of scientific debate, sometimes the debates look different, you know, after the fact. So have you gone through and just scrubbed the way the debates were handled within the firm so that there's no surprises, you know, as the litigation proceeds?

Well, Lawrence, I would say this is a top priority and issue for us as an enterprise and we are taking it, you know, with that in mind. And we have, we formed a corporate affairs organization as part of our business realignment. You know, really it brought together a lot of the people that are working on this, among other issues, because there's, you know, broader brand and reputation strategies that they're focused on. But we have, we've invested in, I think, a bigger, you know, bigger capability around how do we look at it? How do we manage it? You know, and how do we, you know, how we really take our brand and reputation and take that forward as a company? So the answer is we are stepping up to it. It is a, you know, it's a, you know, emerging issue that, you know, has certainly gotten bigger as we went through the last year. And I would say we're stepping into it with every capability and with a lot of good counsel as well.

Thank you.

Our next question comes from the line of Steve Tusa of JPMorgan. Please proceed with your question.

Hey, good morning. Morning, Steve. So when I look at the kind of annual bridge on EPS, I think you guys this year were planning on about 30 to 40 cents from transformation, productivity, and pension tailwind. Are you, are those still, you know, kind of isolated items, are those still on track?

Yeah, Steve, the pension impact, the underlying business transformation productivity, the footprint action savings, those are all on track. But with the lower growth, the two things changing, lower growth and all other productivity, those are the two components that are bringing that part down as well as the charge that we're anticipating in Q2 for the restructuring actions.

Okay, and yeah, and then that entire charge is coming in in Q2, you're gonna take that and run that through EPS?

We think the majority of that, it could be all of it, but we think the majority of that will be in there. Okay, can you just give us

a little bit of color on what you kind of expect now for margins, whether it's, you know, second quarter or the year, I mean, the more detailed the better, so we can all kind of calibrate and reset ourselves from this level, operating margins.

Steve, when we take into account our recent acquisition of EmModel, when we take into account this restructuring charge, we're seeing margins down likely 100 basis points for the year with those two items contributing just over half of that total decline in the margins. And that's different from three months ago when we were saying we were expecting margins to be up, the core underlying productivity, even with these actions, we don't think it's going to be accretive to our margins yet this year, we think that will come later.

Right, and one last quick one, so you mentioned Minnesota on the PFAS stuff, I thought you guys already took a charge for Minnesota, was that, are you saying we already took that charge, so we're just reminding you of it, or was there an incremental charge in Minnesota?

Yeah, Steve, it was, I would say a bit of a reminder, but it was just to let you know, this encompasses those facilities. There was a small part of it that just is part of Minnesota as we look ahead, but it was, the 850 was the majority, the vast majority of what we faced in Minnesota.

Yeah, that charge

last, the 850 is the last year,

Steve.

Yeah. Yeah, no, no, I was just, I'm trying to kind of like, I just, I don't know whether the, I thought the 850 kind of ring-fenced it, for lack of a better term, so the fact that there's kind of another charge in Minnesota, I'm just trying to kind of, I'm definitely haven't done, I'm not a lawyer, I have a lot of work on this side, I thought kind of the 850 took care of Minnesota.

Yeah, and that's the way to think about it, Steve. This was just to make it complete, so that we didn't leave Minnesota out and then have it kind of questioned by exception. Yeah, okay, great, thanks a lot, guys, thanks for the detail.

Our next question comes from the line of Nigel Cole of Wolf Research, please proceed.

Thanks, good morning, guys. Good morning, Nigel. I just want to pick up on Steve's point there, what was the trigger point to make this NID charge, you know, probable and estimable? I know there was a ruling in New Jersey, was that the sole trigger point or was there something else that we were missing?

With the NRD, I think, believe what you're talking about, Nigel, is a year ago, I think what you're really asking is, what's the triggering point for us to be taking this charge now in the first quarter? And we've been working on that with a number of the parties where we have litigation going on, and we reached a point where we felt that, based on the progression of those NIDs, of those, the facts on those cases and where we stood with potential settlements, we actually did have some settlements occur in the first quarter, which gave us better visibility and how to estimate more broadly across all our manufacturing sites what we see as our liability. And by the way, the New Jersey is not one of the places where we manufacture. That's a different lawsuit related to the use of the product and not related to our five manufacturing sites, Nigel.

Okay, that's great. And then just one quick one on kind of the 2Q setup. You talked about maybe 100 base points of channel. We've got the selling day, headwind moves away, one key to 2Q, but then we've got a tougher comp about two, three points. Would you expect the level of status that 2Q would remain sort of in this low single-digit decline range?

Nigel, it would not surprise me if we were looking at negative organic growth in the second quarter. Okay, thanks, guys. Good luck.

Our next question comes from the line of John Walsh of Credit Suisse. Please proceed with your question.

Hi, good morning. Hey, John. I guess maybe just to follow up on Nigel's question about that point of inventory, does your guidance assume that that comes back, i.e., you know, there's some refill at some point in the year, or is that contemplated as just these inventories are now going to remain where they are for the balance of 2019?

Yeah, John, it really is the latter. You know, it's more a model of it remains. For inventory to come back, there would have to be a noticeable upturn in the market. And that, you know, with some of the outlook for the second half, that could be possible, but that's not what we're looking at. We're looking at the adjustment down levels out, and we manage at that level as we go through the year.

Gotcha. And then I guess, you know, can you give us an update on, you know, there was a lot of focus at the analyst day on this billion-dollar sales bucket of priority growth platforms. Can you give us an update of what they did in the quarter?

John, so we'll update you maybe in more detail as we go forward, but we saw very good progress across those priority growth platforms. There's two things that we measure. One is the revenue, and the second is, you know, are we making progress in the milestones, the product launches, the specifications? And you take automotive electrification, and we saw significant wins in Q1 in new spec-in business, and we continue to see strong, you know, upper single double-digit growth even in that portfolio. And I would say across the businesses, this has been one of the bright spots. You know, when you look at quarter like this, you know, there's a lot of challenges, and it's disappointing, but there are some businesses in some bright spots, and we had good business performance in our existing portfolios, and we certainly would count our priority growth platforms as one of the positive contributors to growth, and new products more broadly, but those priority growth platforms are even stronger. So I'm pleased with where we are. We're tracking to our plans, and we can update individual programs when we talk to you.

Okay, thank you.

This concludes the question and answer portion of our conference call. I will now turn the call back over to Mike Roman for some closing comments.

Okay, thank you. To wrap up, we are moving with urgency and taking action to strengthen our performance in 2019 while investing for the future. I remain confident in the world-class capabilities of our enterprise and in our 3M model. We know we have to rebuild our credibility. I'm confident we will get our performance back in line with the expectations of our investors. Thank you for joining us.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.