3M Company

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 will conduct a -and-answer session. At that time, if you have a question, please press the 1 followed by the 4 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 Tuesday, October 27, 2020. I would now like to turn the call over to Bruce Germaland, Vice President of Investor Relations at 3M.

Thank you and good morning, everyone. Welcome to our third quarter 2020 Business Review. With me today are Mike Roman, 3M's Chairman and Chief Executive Officer, along with Monish Patalawala, our Chief Financial Officer. Mike and Monish will make some formal comments and then we'll open it up for questions. Please note that today's earnings release and slide presentation accompanying this call are posted on our Investor Relations website at 3M.com under the heading Quarterly Earnings. Please turn to slide 2. Let me remind you to mark your calendars for our fourth quarter earnings call, which will take place on Tuesday, January 26, 2021. Please take a moment to read the forward-looking statement on slide 3. During today's conference call, we'll 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 10Q lists some of the most important risk factors that could cause actual results to differ from our predictions. Finally, throughout today's presentation, we'll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments in today's press release. Please note, we have provided segment and total company adjusted EBITDA reconciliations for reference in today's press release attachments as part of our non-GAAP measures. Please turn to slide 4, and I will hand it off to Mike. Mike?

Good morning, everyone. I hope you and your families are staying safe and healthy, and I thank you for joining us. As you have seen in our monthly sales reports, we saw significant improvement sequentially in trends versus Q2 across businesses and geographies, and we returned to positive -over-year organic growth. While we remain in a highly uncertain economic environment, it is a credit to our team that 3M continues to execute well, deliver value to our customers, and fight the pandemic from every angle. We continue to prioritize protecting our employees, frontline healthcare workers, and the public while supporting the reopening of economies around the world. We have distributed 1.4 billion respirators -to-date, on track to 2 billion by the end of 2020. And we will exit the year at an annual run rate of 2.4 billion as we continue to add capacity. 3M innovations are also supporting the development of new vaccines and lower-cost testing methods that can be mass-produced. Our operational performance was strong, and we posted another quarter of robust cash flow, aggressively managed costs, and further strengthened our balance sheet. Though our focus remains on executing in this environment, we are also looking ahead and investing in both growth and productivity, while advancing our core values, including sustainability, diversity, and inclusion. Overall, we are competent in our ability to lead in the economic recovery as we take actions to transform 3M and realize new opportunities from emerging customer needs and global market trends. Please turn to slide five. Companywide, total sales increased 5 percent -over-year and 16 percent sequentially to 8.4 billion dollars, slightly above our estimates. With respect to organic sales, we delivered growth of 1 percent -over-year, with adjusted earnings of $2.43 per share. In the third quarter, demand remained strong in personal safety, along with areas such as home improvement, data centers, and biopharma filtration, and we see continued momentum in these end markets into October. While we saw improvement in other end markets versus the second quarter, many remained down -over-year, including health care elective procedures, auto OEM, and general industrial. Geographically, we experienced notable improvement in the Americas, led by the U.S. up 5 percent organically, with strong growth in personal safety, consumer, and health care. EMEA was flat, versus down 15 percent in Q2, while Asia Pacific was down 3 percent organically. We delivered growth of 8 percent in China, with all business groups above 6 percent, offset by Japan, which continues to be challenged. Our execution was strong, as we posted adjusted EBITDA margins of 29 percent, with all business groups at or above 27 percent. Our adjusted free cash flow increased to $2.2 billion in the quarter. -to-date, we have expanded cash flow by 19 percent, and are on track to deliver another record performance in 2020. Continued strong cash flow has enabled us to reduce net debt by $2.8 billion, while returning $2.5 billion in dividends to shareholders through the first nine months of the year. Looking ahead, this continues to be an uncertain environment, and customers and channel partners remain cautious. We will stay focused on serving our customers, driving operational improvement, and investing for the future. Please turn to slide 6. Over the past several months, customer and stakeholder trust in 3M has grown because of how we have delivered through the pandemic. COVID-19 is rapidly changing the global economy and the way people live, work, and communicate. Years' worth of changes are unfolding in a matter of months, creating opportunities to unleash the power of 3M science to drive sustainable long-term growth. For example, with people at home more, there is growing demand for products to both maintain and improve households. This includes indoor air quality solutions, where we've increased investments in our filtrate portfolio to introduce new, innovative products and create additional capacity. As a result, our air quality platform has grown double digits -to-date, as we keep families healthier and more productive. And we expect this market trend to continue. An increased focus in other areas like personal safety, automotive electrification, and biopharma filtration, to name a few, also open additional opportunities for 3M. At the same time, end markets like office, hospitality, and oil and gas have been highly impacted by COVID-19 and are declining as a result. To strengthen our competitive edge, we will invest where demand is strong, pull back where needed, stay close to our customers, and create new innovations that address global market trends. We execute these strategies in normal times, but in the unprecedented times we are in now, prioritization is especially important. I'm also encouraged with the benefits from the new global operating model we implemented this year. A significant step in our transformation designed to improve growth and efficiency and allow us to adjust faster than ever to the external environment. During COVID-19, the strength of our model has never been clearer. From our ability to deliver a three-fold increase in global respirator production this year to the reconfiguration of our supply chain that enabled us to import more than 200 million respirators into the U.S. from Asia Pacific. In a matter of weeks, we also fully scaled up two new respirator lines at a plant in Sheboygan Falls, Wisconsin, a process that would normally take several months. Those lines are now operating at rates 30% above similar lines as we've incorporated significant new technologies and analytic platforms, and we continue to further optimize production volumes. While we have made progress, more work remains to build a stronger and more agile enterprise. Moving forward, we will continue to optimize our new model, digitize our operations, and improve the customer experience. All of these actions, combined with relentless focus on operational execution, will enable us to deliver greater value for our customers, shareholders, and all stakeholders as economies recover from the impact of COVID-19. That wraps up my opening comments, and I'll turn it over to Monish to cover the details of the quarter and our perspective on Q4.

Monish. Thank you, Mike, and I wish you all a good morning. Please turn to slide seven. Companywide, third quarter sales were $8.4 billion, up .5% year on year, with adjusted operating income of $1.9 billion in line with last year. Third quarter adjusted operating margins were .9% versus .8% last year. As the company disclosed, and you may recall, we recorded a $58 million gain from the sale of real estate in Q3 last year. This gain produced a 70 basis point headwind year on year to adjust operating margins. Turning to this year's third quarter, our ongoing cost management and productivity efforts were more than offset by impacts from the COVID-19 pandemic. This resulted in a net 50 basis point reduction to margins versus last year. Acquisitions and divestitures lowered margins by 20 basis points year on year, which includes a negative 50 basis point headwind from the Assellity acquisition due to purchase accounting impacts. Operationally, Assellity delivered a solid third quarter as healthcare elective procedures picked up sequentially. Based on Assellity's first year performance and integration progress, we are confident in the long-term success of this business. Please note that Assellity will now be reported as part of our organic results starting in Q4. Higher selling prices combined with lower raw material costs contributed 80 basis points to third quarter margins. And finally, foreign currency net of hedging impacts decreased margins by 30 basis points. Let's now turn to slide eight for a closer look at earnings per share. Third quarter adjusted earnings were $2.43 per share versus $2.58 per share last year. The 15-cent year on year earnings decline is primarily due to two items. First, as discussed on the prior slide, the Q3 2019 $58 million real estate gain resulted in an 8-cent per share earnings headwind year on year. And second, our third quarter adjusted tax rate was .4% versus 19% last year. Resulting in an 8-cent year on year headwind to earnings per share. This headwind is primarily a function of last year's tax rate. Finally, acquisitions and divestitures contributed 1 cent to earnings. Please turn to slide nine for discussion of our cash flow and balance sheet. We delivered another quarter of robust free cash flow with third quarter adjusted free cash flow of $2.2 billion up 13% year over year. The third quarter cash flow performance was driven by significant improvement in working capital, which contributed over $330 million of cash. Off note, we delivered an underlying decline in inventory of $240 million since the end of Q2. This reduction was largely driven by the 16% sequential improvement in sales, along with our continued work to improve inventory velocity. Looking ahead, we will continue to adjust our manufacturing production and inventory levels to meet changing customer demand trends as the impact of the pandemic on the economy evolves. While the working capital progress is encouraging, the team continues to work on improving operating rigor through daily management to drive sustainable long lasting improvement. Year to date, we have generated adjusted free cash flow of $4.6 billion up 19% versus last year. Third quarter capital expenditures were $368 million and nearly $1.1 billion year to date. For the full year, we now anticipate capex in the range of $1.4 to $1.5 billion versus approximately $1.4 billion previously. During the third quarter, we returned $847 million to our shareholders via dividends. Share repurchases remained suspended throughout the quarter, given the continued global economic uncertainty. Our strong third quarter cash flow generation and disciplined capital allocation enabled us to continue to strengthen our capital structure. We ended the quarter with $4.6 billion in cash and marketable securities on hand and reduced net debt by $1.3 billion or 8% sequentially. Year to date, we have improved our net debt position by $2.8 billion or 16% since the start of the year. Looking ahead, our priorities remain unchanged as we continue to focus on driving strong cash flow performance, maintaining disciplined capital allocation while continuing to strengthen our financial flexibility to invest in our business and to return cash to our shareholders. Please turn to slide 10 where I will summarize the business group performance for Q3. I will start with our safety and industrial business, which posted organic growth of .9% year on year in the third quarter. Personal safety posted double-digit organic growth year on year as we continue to experience unprecedented levels of demand for respirators globally in response to the pandemic. Automotive aftermarket improved sequentially and was up 1% year on year as auto body shops reopened after the economic shutdowns in Q2. The strong growth in the residential housing market continued to drive good performance in our roofing granules business, which was up low teens organically versus Q3 of last year. The balance of the safety and industrial portfolio, namely abrasives, closure and masking systems, adhesives and tapes, and electrical markets, improved sequentially but remained down year over year organically as customers and channel partners remained cautious given the continued macroeconomics uncertainty. Looking geographically, the Americas grew 11% organically with the U.S. up low teens. EMEA also grew 8% while Asia Pacific was down low single digits. Safety and industrial's third quarter segment operating margins were 27.2%, up 430 basis points driven by sales growth, continued strong productivity and spending discipline. Moving to transportation and electronics, third quarter sales were down .1% organically compared to last year. Our electronics related business was up 1% with continued strong growth in semiconductor, factory automation and data centers, which is partially offset by -on-year weakness in consumer electronics, particularly in smartphones. Our auto OEM business was down 4% -on-year compared to the 3% decline in global car and light truck bills. -to-date, our automotive business has outperformed global bills by approximately 400 basis points. Beyond automotive bills, the pandemic also continues to have negative effects on end markets such as hospitality, oil and gas, advertising and highway infrastructure due to social distancing and work from home protocols. These soft end market trends resulted in -on-year organic sales declines in our commercial solutions, transportation safety and advanced material businesses. Geographically, Asia Pacific declined 3%, while the Americas declined 11% and EMEA was down 16%. Transportation and electronics third quarter operating margins were 23.9%, negatively impacted by the 7% decline in organic sales, which is partially offset by continued cost discipline. Turning to healthcare, both organic growth and operating margins in this business improved from Q2 levels, as elective healthcare and oral care procedure volumes improved after experiencing significant pandemic-related challenges and disruptions across the industry in the second quarter. Overall, our healthcare business delivered Q3 organic sales growth of .1% -on-year, with operating margins of 23.5%. Medical solutions grew mid-teens, including the impact from continued strong pandemic-related demand for disposable respirators to protect frontline healthcare workers. Excluding the respiratory impact, this business declined low single digits, as elective procedures remained significantly below 2019 levels. Our oral care business returned to positive growth in Q3 of low single digits organically, driven by the reopening of dental offices globally and the rebuild of channel inventories. Looking ahead, while we have seen improvement in both medical and dental procedures, currently procedures are leveling off and are forecasted to remain below pre-COVID levels through the end of 2021. Our separation and purification business increased low teens -on-year. This business continues to experience strong demand for biopharma filtration solutions in support of the pharmaceuticals industry's research and manufacturing efforts to develop vaccines and therapeutic treatments for COVID. Turning to health information systems, this business declined mid-single digits organically in the quarter, as hospitals remained cautious relative to their information technology investments. And finally, food safety declined low single digits, as the pandemic and related prevention protocols continue to negatively impact the food services industry. Looking geographically, the Americas grew 13%, EMEA also grew 9%, while Asia-Pacific declined 4%. As I mentioned, healthcare's third quarter operating margins were 23.5%, down 320 basis points -on-year. Margins were negatively impacted by the facility acquisition and investments in productivity and growth, which were partially offset by the ongoing cost discipline. Looking sequentially, operating margins improved 670 basis points, with 60% sequential leverage on 18% growth in sales. Lastly, second quarter organic growth for our consumer business was up 5.5%. Organic sales growth within consumer continued to be led by our home improvement and home care businesses. Each up low double digits organically. Growth in these businesses was driven by strong customer demand for our filtrate air filtration products, Scotch blue painters tapes, command wall hanging products, Meguiar's car care products, and Scotch bright cleaning products and solutions. Stationary and office declined double digits as a result of many business offices and schools remaining partially or fully closed due to the pandemic. Looking at consumer geographically, the Americas led up 7% organically and EMEA grew 5%, while Asia-Pacific declined 1%. Consumers operating margins were 25.3%, up 200 basis points on strong organic sales growth and cost discipline. Looking ahead, we expect to continue to step up investments in advertising and merchandising and new product innovation to address changing consumer demand trends. That wraps up my review of our third quarter business performance. In summary, we continue to execute well in a highly fluid and uncertain macro environment. We returned to positive organic sales growth, delivered solid operating margins of nearly 23%, increased adjusted free cash by 13%, reduced net debt by 8%, while also investing in both growth and productivity. Please turn to slide 11 and I will discuss our thoughts on Q4. As we enter the fourth quarter, significant economic and end market uncertainty continues to persist as both global GDP and IPI are currently forecasted to remain negative year on year. Therefore, we remain cautious as the impacts of the pandemic on the global economy and end markets continues to evolve. From an end market perspective, we do expect continued strength in certain end markets, namely personal safety, home improvement, general cleaning, semiconductor, data centers and biopharma filtration. At the same time, year on year declines across many end markets such as healthcare and oral care elective procedures, automotive OEM, general industrial, consumer electronics, hospitality and the office supplies are expected to persist through the balance of this year. In fact, many of these end markets are not expected to recover to pre-COVID levels until well into 2021 or beyond. Turning to our business, we currently estimate October total company sales growth to be flat to up low single digits, which incorporates the anticipated impact of one few business day year on year. Please note, relative to business days, that there is no year on year impact for the fourth quarter. However, on a sequential basis, we will have two fewer business days in Q4 as compared to Q3 this year. As we have done over the past several months, we will provide our monthly sales information through the end of the year due to the continued global macroeconomic uncertainty. Therefore, we will report October sales once we have finalized those results in a few weeks. Regarding disposable respirators, we expect continued strong demand, which we anticipate will contribute approximately 300 basis points to company-wide Q4 total sales growth. And as a reminder, we will have a negative fourth quarter sales impact year on year of approximately $100 million or 130 basis points from our May 2020 divestiture of drug delivery. From an operational standpoint, we will maintain a strong focus on cost management while continuing to invest in both growth and productivity. With this in mind, we expect our fourth quarter adjusted operating margins of approximately 21%. Finally, we remain focused on generating strong cash flow, disciplined capital allocation, and strengthening our balance sheet and financial flexibility. To wrap up, I would like to thank all three EMRs for the hard work this quarter and the progress that we have made. In the spirit of continuous improvement, there's always more we can do. Our team remains focused on fighting the pandemic from all angles, relentlessly serving our customers, delivering growth in revenue, margin, and cash, strengthening our balance sheet, and driving operating rigor through daily management. With that, I thank you for your attention, and we will now take your questions.

Thank you. 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. Our first question comes from the line of Dean Dre from RBC Capital Markets. Please proceed with your question.

Thank you. Good morning, everyone. Hi, Dean.

Hi,

Dean. With respect to the precision that you can provide and have been providing on the contribution from respirators, is it possible to take a stab at a net COVID impact across 3M, or maybe the size like the key positives and key negatives? And positives, I would imagine, are other PPE and the home improvement trends and so forth. But if you could net, you know, size the biggest outliers on both sides of that equation and how you think that nets out as you see it today? Yeah,

and Dean, I would start with our entire business portfolio has been impacted one way or another from COVID-19. We talked about respirators, about 300 basis points of growth impact on the enterprise from that demand that we're seeing in respirators. About half our businesses do remain down year on year. So we highlighted a couple others that are up. You hit them as well. Our home improvement business, our separation, purification, our biopharma filtration business, those are both up low teens. You look at some of the ones that have been impacted negatively, our office markets, I would say in our hospitality, kind of the commercial solutions, those are both down low teens. So it kind of gives you a view of how the impact plays out on both sides of that, both the positive demand and some of the impacts negatively from COVID.

That's helpful. And? I would just add Dean, I think the other pieces we've also hit on elective procedures, so they are also down year over year. So that impacts our healthcare business. And then on the positive side too, the other piece I would throw out is as the economy moves to a digital first, thinking about how we play in a semiconductor space, data centers, factory automation is another area of strength that has helped us in through COVID.

Got

that.

And then as a follow-up, when I looked at the guidance that you had given with a framework for the third quarter, and you came in pretty darn close to and actually above on revenues and above on margins, what might be the prospects for restoring guidance? I know you've given our framework for Q, but just if you're in the position where you're pretty darn close at this stage, when might guidance be restored? And when might you restore buybacks? I mean, you commented on discipline, capital allocation, but you had really good cash flow, you paid down debt. When might buybacks be restored? Thanks.

Yeah, Dean, maybe I'll take the first part of that and just talk about how we think about guidance. And as we went through Q3 and got halfway through September, we did give you an estimate of how we were seeing sales. Behind that, still a lot of uncertainty about how this is going to play out, how the economy is going to impact the businesses we were just talking about. And that remains true today. The current environment, it remains uncertain. So we continue to keep our guidance withdrawn. We're going to focus on executing well against what we see coming and we'll continue to report monthly sales. As soon as we get better visibility of the market outlook and the trends, then we will look at bringing back a view of guidance. But for now, we'll stay with the monthly sales reports.

And as I go to capital allocation, Dean, just our priorities haven't changed. What we've always said is our first priority is investing organically because that's where we believe we get the best return. Our second priority has been paying dividends. Dividends have been a hallmark of 3M and I know our investors care about it. So that's our second priority. And then our third priority is M&A and then with that is share buyback. So that's the way we look at our four. As you know, through the pandemic and through the uncertainty that's going on, we have strengthened our financial position, as you saw, by reducing net debt. We also suspended share buyback at the end of first quarter. And right now, as we have announced, our share buyback remains withdrawn. We are working on 2021. We have multiple scenarios. And as we finalize that, we'll keep you updated as appropriate.

Thank

you. Definitely,

Steve. Thank you. Our next question comes from the line of Scott Davis from Mellius Research. Please proceed with your question.

Hi. Good morning, guys. Scott. I'm, are you guys surprised at all the healthcare margins weren't a little bit better just given the 8% growth, you know, the operating leverage that you would typically get from that?

No, I think, I would say, Scott, we're pretty much online. The team's done a nice job of controlling costs. As you can see sequentially, our margin rates have gone up 670 basis points. And that's driven a lot by the fact that the team's done a nice job, as well as the volumes have picked up, you get the operating leverage. And that's what we've seen. So nothing untoward. The thing that you also have to keep in mind on a -over-year basis, as we bought SELITY, and the impact of the purchase accounting nearly causes a 220 basis point drag on a -over-year basis due to purchase accounting.

Yeah, I saw that. So, okay. I'll move on. The price in the quarter that you quoted in the earlier slide, I think, you know, 60 basis points, I believe, that's a pretty good number in a recession, particularly given that raw material costs are low, so it's not pushing up prices. Is there any way to kind of tease that out? Is that a new product, and so therefore it's kind of, you know, partially price mix? Is it just the fact that there's certain products you have that are in really high demand right now, and so you're getting price in that area? Is there just maybe some high-level commentary there would be helpful? Sure,

Scott. The price was 60 basis points, and I agree with you. The team's done a good job of driving it, but as you know, that's the innovation model. The company has historically managed to get 30 to 50 basis points, and part of it is just the strength of the innovation and the customer value we add. On the price over 60, I would say the Americas and the EMEA were both that we saw price increase. Asia Pacific was down on year over year, and I would say there's nothing I would call out as specific or one product line that drove it. It's a general increase that we've seen across multiple markets and the products that we have introduced this year, as well as the pricing actions that were put into place at the beginning of the year and they are holding.

Okay, helpful. Good luck, guys. I'll pass it on. Thank you.

Thanks,

Scott.

Thank you. Our next question comes from the line of Nigel Koh from Wolfe Research. Please proceed with your question.

Thanks. Good morning. Hey, Nigel. Hi, Nigel. I mean, I think the September was a bit weaker than what you saw in July or August, and maybe October got a little bit better than September. I mean, again, I don't want to play the interest here, but can you just make comments, you know, number one, if that's kind of correct on a various basis, and then secondly, you know, what you've seen in terms of channels, you know, by business as possible, and, you know, kind of did we see a big restock, you know, through the summer that perhaps that's now played through? Any information that would be great.

Nigel, maybe I'll start with the second part of that. Just looking at the channel, we haven't seen strong restocking across most of our portfolio. Maybe some in health care as elective procedures have come back. And I would say otherwise the channel has been cautious and we haven't seen a strong restocking as we went through third quarter, even as we come into October. So if you think about how sales trended as we went through Q3, you know, we came in a bit better than the range that we said, the 8.2 to 8.3 billion. Overall revenues were pretty consistent through the quarter. You know, two months we had sales, we were up about 4% for the full quarter. We grew about 4.5%. You know, normally, and I would say pre-COVID, we would see a strong upward trend as we go through September and as the quarter progresses. In both Q2 and Q3, that trend is there, but not at the historical level. So looking through that and then what we, what Monish mentioned about October, that through the early part of October, we're seeing flat to low single digits. The sales trends have been pretty steady through the interim quarter of Q3 into the start of Q4.

Okay, that's great. Well, I'll follow up offline with Bruce on that. And then my follow up question is on inventory. You've taken down inventory, you know, a fair bit into from TQ to 3Q, I think down roughly $200 million. It implies that your production volumes were down, you know, probably low single digits year over year. So I'm curious if that had an impact on fixed cost absorption, because the margins were pretty impressive. So I'm just wondering if there was a drag from that inventory reduction. And then do you expect to continue reducing inventories into 4Q and perhaps 2021?

Sure. I'll just start with the first one. So the team's done a nice job on inventory reduction. As I said earlier, I would say there are two pieces that drove it. One is you saw the volumes quarter over quarter sequentially up nearly 16%. I would say that's just number one that drove it. And secondly, the team has been focused and is focused on driving inventory velocity up. And those are the two factors. For example, they started using a lot of data and analytics that helps us decide where our inventory levels should be. There's always more work to do there, but that's another driver of how we were able to drive this down. I would say to your second question, do you see it going down or not? I think our philosophy hasn't changed on making sure that our inventory levels keep going down and our velocity keeps going up. But it's an extremely uncertain environment. So you're seeing markets that are up a lot. You're seeing product lines that are down a lot. Mike already touched about some of the lines where we were down double digits and some other lines where we were way up double digits. So I think that's what we are working on balancing. So we'll decide as the pandemic settles out what our production levels should be, what our inventory levels should be. But overall, I would count on you count on us to make sure that our inventory levels from a velocity perspective keep improving. And then your last question on on manufacturing unabsorbed cost. So as you know, some lines are up or down. We have incurred costs, which is approximately $35 million of fixed cost that are unabsorbed manufacturing variances.

I think I've got five questions there, so I'll leave it there. Thank you very much.

Thank you. Our next question comes from the line of Andy Kapowitz with Citi. Please proceed with your question.

Hey, good morning, guys. Hey, Andy. Muneesh, maybe you can give us a little more color into your adjusted operating margin guidance, the 21 percent for Q4. You obviously recorded a much higher margin than that in Q3. Incrementals were good sequentially, above 40 percent. Obviously, we know two fewer selling days, so lower sales. But is there any other margin impacts on the business in Q4 versus Q3, mix, or maybe you expect temporary costs to come back faster in Q4? Yes,

I would say, Andy, there are quite a few factors that go into it. I'll just start again with just with the uncertainty that's in the market and volume is a big driver of it. We're seeing GDP and IPI both are going to be down year over year or projected to be down. We've also seen uncertainty in the market in general. We are seeing places where, for example, where I said health care procedures are leveling, customers are remaining cautious, et cetera. So there's a lot of uncertainty in that market. On the flip side, we continue to see pretty good end market trends, whether it is on our personal safety, our home cleanliness, and our home improvement business, and then biopharma filtration. So when you put all that together, the team will continue to monitor that as the economy evolves. We are continuing to focus on making sure that we are being very cautious on cost. But at the same time, we will invest in growth and productivity where required. So you're going to see both sides here. You saw us talking about investing in some of these segments that we see that in the longer run, we have growth potential. So with all that put together, as well as just remember sequentially, historically too, Q3 versus Q4, we always see a drop in margins. Q4 is the lowest for 3M, and part of that is driven by just the two lower billing days that you get on a year over year basis. So the fixed cost gets spread over a shorter number of days. So with all that put together, we believe right now the line of sight we have is to 21%.

That's helpful, Maneeshan. And maybe just to follow up on that, can you give us more color into the margin performance and safety in industrial and consumer? The margins are recording Q3 in both those segments. We really haven't seen those kind of margins from 3M in those segments. So maybe the sustainability, if temporary costs come back, how much of the tailwind that you're seeing is from some of the long-term things you've been doing, like business transformation, factory optimization? And I think you mentioned advertising. Maybe you're doing less advertising consumer. But do you see these types of margins being sustainable as you go forward in these two segments as you go into 21?

Sure. I'll start with just giving you the reasons for the strong growth, and then I'll talk about what we think on the future. On the growth, in SIBG, the margins were driven by two pieces. One is extremely strong demand for our respirator business. So that's one. As well as our sequential improvement, pretty much across all the industrial product lines have helped us from an overall cost position. And secondly, the team has done a great job of being very cautious on how much, on being cautious about the spending levels. And I think both of that. But at the same time, the industrial business, the safety industrial has continued to invest also where we see the growth opportunities. And then on the consumer side, it's driven again by strong growth in our home care business and our home improvement business, which has also helped us from a margin rate perspective. The point on advertising and merchandising that I was bringing on is the team has spent what they think is appropriate in this environment. But as we are starting to see markets come back up and seeing some of the future trends in this area, we are going to continue to invest in advertising and merchandising, as well as investing in new product innovation as required. But I think I would say that in general is the philosophy that we're going to follow, which is we're going to invest in growth and productivity in areas that we feel that has long term potential for 3M. At the same time, we'll dial back in areas or reprioritize in areas that we feel in the short run may not give us the big bang for the buck. So that's the way we would think about it.

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

Hi, good morning. Hi, John. So I wanted to go back to kind of the capital allocation strategy. You know, if we take where you ended this quarter after some delevering actions, you know, just I'll use consensus numbers here, but you take what you're forecasted for free cash flow, less the dividend, you look at the EBITDA projections. I mean, there's a path here for you to end next year below one and a half turns of net leverage. Is that where you're trying to get to? Would you push back on any of that? I just wanted to get your thoughts on, you know, where you actually want to get the net leverage down to.

Sure, John. As Nick and Mike had said before my time, too, the company wanted to get below sub two on a net debt to EBITDA leverage. And we are right now where we are. So we are at one point eight at the end of Q3. The way I look at it is again, it's an extremely uncertain environment right now. So we don't have any target that we're going other than we want to keep strengthening the balance sheet, keep giving us the financial flexibility. And that's what we're doing. As we get into 2021, we'll see how the world looks like from that trend. And at that point, we'll make a decision. But you should just count on 3M to have a strong balance sheet. And that's what we're going towards.

Got you. No, thank you for that. And then, you know, just thinking about, you know, some of the uses of that potentially, you know, any update here around environmental, you know, thinking about an EPA action plan and or anything on the calendar just for investors to be aware as we think about, you know, what 2021 looks like. I think he provided an update last quarter. I was just curious if anything changed.

Yeah, John, maybe I'll start where we always start. We're proactively managing that really EHS and PFAS kinds of strategies. And we do that around sound science, corporate responsibility and transparency. So trying to keep you updated as we go here. And your question about EPA, we've been supportive of the EPA's plan for managing PFAS. And we've been working in support of them with our commitments to provide a clearinghouse of information around that. When you look at how do we look at 2020 and 2021, I would say we continue to work as 3M around our manufacturing sites, around historical disposal. And we continue to make progress on that. When you look at potential other actions and other EHS matters, I would say there's been a slowdown with some litigation actions as part of that in the middle of COVID. So now we're looking at trials and related matters next year, first half of next year. So whether it's about whether trials in Michigan or the multidistrict litigation actions, those are coming now sometime early, the first half of next year. So nothing more. The reserves that we've taken for the work that we've been doing on our manufacturing sites, those cover what we see as probable and estimable today. So that gives you kind of an updated outlook into early next year.

Great.

Appreciate

all the color.

Thank you. Thanks, John.

Our next question comes from the line of Andrew Obin with Bank of America. Please proceed with your question.

Thank you. Good morning.

Good morning, Andrew.

Nice sequential improvement on healthcare, but sort of longer-term question. You know, this used to be 28%, 30% margin business, or another way to ask it, in 2017-2018, you could make around $500 billion with -1.7 billion of revenue, and now it sort of takes $2.2 billion of revenue to make that. Can you just bridge the gap, you know, where we were and where we are now? And I get that facility is, you know, 200 basis points plus. But what are the other big buckets that sort of drive this decline in margin, and what would it take for it to come back?

Yeah, Andrew, this is Bruce. If you look at the EBIT margins of healthcare, they're right at 30% here in the quarter. So the big driver of, there's two items really that impact margins as you look at it historically. The realignment of the company when we moved the separation purification business into healthcare had below average healthcare margins. So that had a negative impact. And then secondly, the DNA associated with the cell of the acquisition is impacting the margins. So peeling that back though, you know, healthcare right now is right around 30%. So kind of back to the upper 20s, around 30% range. Gotcha.

And then the second question is on elective procedures. You sort of did, I think you sort of indicated slow down in September-October. Can you just comment as to what explicitly you guys are saying on elective procedures? And are you seeing a slowdown related to the second wave of COVID? And how is the second wave of COVID factoring your forecast for healthcare and across the board for the company?

Yeah, Andrew, just if you look at Q3, we saw an increase in elective procedures coming into Q3. We saw that coming out of Q2 starting and then coming into Q3. And that was behind some of the improvements that you saw sequentially in the healthcare business broadly. We, as Munish mentioned in his remarks, we've seen a flattening of elective procedures, not necessarily a downturn, but a slowdown and a flattening as we exited September and come into October. So back to what's driving it, there's a lot of uncertainty of will it pick back up? Will it stay flat? I would say we are continuing to remain cautious there as well. And that... So just... Sorry. Go ahead.

So are you effectively modeling no sequential acceleration in elective procedures due to COVID? Is that just part of the framework?

So I'll just first answer a little more on with numbers. So if the US and Europe with the data that we see, Andrew, was at the end of third quarter between the 70 to 75 percent of pre-COVID levels in those two parts of the world, China, of course, was a little higher and between the 85 to the 90 percent. And as we said, I think what we are seeing is a flattening. I think there's nervousness right now with some of what's going on in the world, of course, with the outbreaks of COVID in a few of the regions. And we have multiple scenarios that we are watching. And as I mentioned, we believe elective procedures will be down on a year over year basis. And you can pick that range, but we believe it's going to be... Right now, what we're seeing is pretty much flat October to September. Thank

you.

Thanks, Andrew.

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

Thanks. Good morning, everybody. Hi, Joe. Okay. So my first question is maybe just focused on the actions that you had announced previously. I think you had announced something like $400 million or so in cost actions in the second quarter. And I know a lot of those actions were expected to be temporary. I'm just curious, how did those play out into three Q? And is there still any kind of carryover benefit from those cost actions that we should expect into four Q?

Sure, Joe. I'll answer both separately. On the $400 million, as announced, as you correctly stated, most of them were temporary in nature. And some of them, as we had also disclosed at the end of Q2, have a reversal impact in Q3 and Q4, especially vacation accruals become negative in Q3 and Q4, as well as the timing of our bonus accruals, AIP accruals become negative quarter over quarter. The overall impact of all that put together was a $50 million benefit in Q3. And then your second question on what do I see going forward? I would say also, if you recall, in the second quarter, we had announced some actions that we had from a restructuring perspective. But that would have an impact in 2021 and beyond. And then in the fourth quarter of 2019 also, we had announced actions that we had taken as we went into the new model of the new transform way of running 3M. And there's approximately $30 million of benefit in that in the second half. Okay.

All right. That is helpful, Munish. And then my one follow-on question, I know it's probably too early to start thinking about 2021. But you do have this phenomena this year, where your respirator sales are helping to boost growth in 2020. And it looks like we're going to be in this pandemic-related situation for quite some time. I'm just trying to understand how you guys are thinking about framing what the either tailwind or headwind could potentially be in 2021 from just the respirator portion of your business.

The way we look at it, Joe, is that we believe respiratory production continues or that demand continues for a long time. So we continue to see, I would say, the strength from that business to grow. We are investing in capacity, as we have announced. We have made around, we'll make around 2 billion respirators this year. We'll exit at a run rate of 1.2 billion for the second half, which is nearly 2.4 to 2.5 billion respirators for 2021. And so our view is that demand remains strong, as well as, you know, we are truly committed to fighting the pandemic from all angles. And this is just one piece of it. Between this, the home cleanliness products, the home filtration products, 3M is doing everything we can to help the world out and make it safer. Thank you. I'll get back in Q.

Thank you. Our next question comes from the line of Julian Mitchell from Barclays. Please proceed with your question.

Hi. Good morning. Morning, Julian. Maybe just, good morning. Maybe just hopefully for you at least one last question on healthcare margins. So, you know, just one that I suppose maybe looking ahead, what do you think the run rate margin level is? What sort of operating leverage should we expect in that segment? Because, you know, I understand the separation and purification going into the segment, I understand the acetylity impact. But, you know, you look year on year at Q3, the margin excess acetylity is still down 100 bips of high single digit organic growth. And I understand sequentially the margin was up in Q3, but I'm guessing it's probably down sequentially in Q4. So just trying to take a step back from all of that looking forward, what do you think the operating leverage is in healthcare? And do you think there are kind of outsized reinvestment needs there?

So I'll answer my question, Julian, with a caveat that I'm 90 days in. But I'll start with the following, that the team has done a nice job. You saw the margins rebound from Q2 to Q3 as the sequentials came through. I think for Q4, which is what we should be looking at, the question that will come around is what's the volume going to be based on where we are with everything that we're seeing in electives and in oral care? And I think that's the big piece. The team will continue to focus on making sure that we are being very cautious on what we spend on cost. But at the same time, as we start seeing the future growth come back post the pandemic, we will not hesitate to invest in growth and productivity, because this is a great franchise for us and we want to keep making sure that it has long term growth and good margin performance too.

I see. And then maybe, Manesh, you know, circling back on that cost question that Joe had touched on, if we look at, say, 2021 in aggregate, you know, with everything that we know today, you've got some fixed costs, I suppose, carry over savings from the Q2 actions, you know, maybe help us understand what that is in totality in terms of the year on year tailwind next year. And also, do you see any headwind next year, as you said today, from temporary costs coming back, or those all came back in the second half of this year already?

Yes, I would say, Julian, we are busy working on building out 2021. So I'll give you definitely more detail as we get into 2021. But as I mentioned, just a few sets of numbers for you is the action that we took in Q2 of 2020 has a tailwind of nearly 110 million dollars in 2021, because that's the restructuring action that we'll take. The flip side of that is, as you know, we have got a lot of temporary measures put into place. We have frozen contractor services, travel, etc. And some of that will come back on a year over year basis, as well as depending on what the future growth potential is, we will be investing in growth and productivity at the same time. So long answer to your question that there are multiple moving pieces. We are in the midst of working through 2021 and will definitely keep you appraised of that as soon as we lock down on our case.

Yeah, Julian, just let me clarify the actions we took, the 110 million related to our Q4 action we announced. The Q2 action we announced is relatively small. Yeah, my apologies. That's right.

Perfect. Great. Thanks, Manesh and Bruce.

Yeah, thank you. Thank you.

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

Hi,

good morning,

guys. Hey, Josh. Hi, Josh.

So just to live a little bit off the current quarter, and Mike, you touched on it a little bit in your opening remarks, but I just want to dig in a little bit more. This lateral antigen test that you were putting together with MIT, if I'm reading this right, I think some of your peers are out there making, you know, a billion of these things a year on a run rate basis. And I would suspect that 3M is probably making it cheaper as, you know, more of a professional manufacturer than some of these other folks. And given the mediums you're working with, how big could this be? Is this something that's any closer to deployments? I think, you know, going hand in hand with needing masks for a while is we're probably going to need tests for a while, too. Yeah,

Josh, let me give you maybe an update here. So this is the testing work that we're doing with MIT as a partner sponsored by the National Institutes of Health. And this has been a focus on a low cost, highly accurate paper based device that can be mass manufactured. So large numbers like you're talking about. And so where we're at, we've created a prototype of that. And this is a saliva based test. And we've demonstrated sensitivity in the lab. And we're currently in a phase where it's being validated by an outside laboratory. And this includes a number of a series of tests, including tests against live samples, positives, negatives, really to determine how good it is at detecting COVID-19 and accurately. And so if that goes well, then we would be looking at ramping it up to production. We would be the next step would be to work with the FDA on an emergency use authorization, probably sometime on the first half of next year to give you a little bit of the timeline. But it is something that would be a volume based low cost test that could be used broadly. So it's, you know, we're excited about the partnership. We're excited about the good progress to this point, but more work to be done.

Got it. And just on understanding the numbers, right, maybe those, you know, that run rate production number that I threw out sounds like it's not too far off, but price per test. I think those peers are five to 10 bucks a test. Does this sound like it'd be on the lower end of that? Maybe a little bit lower. But, you know, the easy algebra there comes up with a pretty big revenue number if all that comes together. Is that fair, but still just too early to commit to a total pay him?

Yeah, Josh, we still have some work to do. So I'll stay with low cost for now and we'll come back as we make more progress.

Got

it. Perfect.

And I see over time, more over time, and I appreciate the color, so I'll leave it there.

Thank you,

Josh.

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

Hey, guys. Good morning. Just wanted to confirm. So October, kind of, if you adjust for the day sales, like up five or something like that, is that kind of the right number to adjust for days?

Well, as Steve, we said it's flat to low single digits October trend. That takes into account that extra day. So trending a little bit above that of the extra day. Got it.

Got it. Sorry, I'm going to miss that. And then just kind of like headed into next year on the top line and any kind of major, sorry, on the bottom line, any kind of puts and takes that we have to be aware of when it comes to pension or anything like that, you know, that's just more mechanical when thinking about next year?

Nothing that I can think of right now, Steve, again, as we get through 21, as we finish up planning for 21, we'll definitely keep you posted. But as of right now, nothing mechanical.

Yeah, and pensions, Steve, obviously, we'll see where rates are at on December 31 and that will determine what the expense is next year. Where would that if you snapped the line today, where would that be? We're not providing that at this point, Steve. Okay, great. Thanks a lot, guys.

Our next question comes from the line of John Inch from Gordon Haskett. Please proceed with your question.

Yeah, thanks. Thanks for squeezing me in. Good morning, everybody. Hey, John. Morning, guys. By the way, I see on page 11 you're really bullish on general cleaning. So can I ask you, what were the what were the third quarter 20 margin benefits of past restructuring actions? If we could just perhaps start there.

Yeah, if you look at third quarter, John, it's pretty minimal because we've lapped now the Q2 actions we took a year ago. And in the Q4 actions that we announced earlier this year, they were somewhat impacted by COVID. And so we put in place, for example, things like hiring freezes as we've gone through COVID. So those actions are going to have more of an impact next year, as Monish mentioned, 110 to 120 million, little impact here in the second half of this year.

OK, Bruce. So then, I mean, to get to 21 percent margins for the fourth quarter, you know, if you look a year ago and you add back the restructuring costs, you get, you know, kind of almost 21 percent. So you're sort of assuming kind of flat pro-forma margins. I was just wondering if you expected contribution from any kind of, you know, cost out tailwinds or other things, just trying to get back to the like to gauge how conservative you're being in terms of your fourth quarter got in 21 percent.

Yeah, there's there's some benefit from the actions we took. But as Monish mentioned earlier, John, some of the actions that we put in place in Q2, such as we encourage our employees to take half of their vacation by the middle of the year becomes a headwind in Q4 because people generally take a fair amount of vacation during the holidays. So plus, we're continuing to make sure we're investing in the business to set up success as we go into 2021. So for now, 21 percent is where we think is appropriate as we start the quarter.

OK. And then just secondly, what do you expect COVID sales to be in the fourth quarter versus the 235 in the third quarter? In other words, sort of how much sequentially and is this sequential sales trend, is it accelerating or is it sort of decelerating as the bulk of just to try and put all of this into the context? I realize you threw out those numbers, 1.4 to 2.45 next year. But what's sort of what's happening to the curve sequentially in terms of the contribution? If you can maybe isolate that. Thanks.

Yeah, John. So we as Monish mentioned, we've added capacity as we've come into the second half or brought it online capacity that we have been working on as we've gone through the year. So that'll have a little bit of an impact. I think it's still in that 300 basis point range for Q4. It's it'll be sequentially up slightly off of Q3.

Sequentially up slightly, even though the fourth quarter is usually a bigger sales number, though, right? No, it's 300. I'm not quibbling. I'm just I'm just trying to understand the context. Normally, I would like it's holding steady.

Yeah, normally you see a sequential decline from Q3 to Q4. Really, typically there's two days difference between Q3 and Q4. That's one of the drivers. It's there's a you know, the holidays have an impact. And so we in respirator, because of the situation we're in, I would say it's going to be similar to what you saw in Q3, maybe a little bit up as we bring that additional capacity online and serve the demand out there.

And then Mike, moving into 2021, do you see COVID sales sort of gently decelerating or do you see more of a like a bit of a cliff and say hitting when they started to really ramp, say in the second quarter or something like that?

John, there's still a lot of uncertainty. I mean, we see demand extending into 2021 for sure. And we're bringing that capacity on to be ready for that. Well, as Munez said, we're getting kind of our view of this as we get further into Q4 and get ready for 2021. We'll come back and give you a breakdown of that.

Good

stuff. Thanks very much. Thanks, John.

Our last question comes from the line of Lawrence Alexander from Jeffries & Company. Please proceed with your question.

Hi, guys. It's Sam Rizzo on the line for Lawrence, which is a quick one. You mentioned health care elective demand has been weak because for obvious reasons. I was wondering if that has accelerated in recent weeks just with all the headlines we're seeing with increasing COVID cases worldwide, if things are getting worse in that particular sub-segment.

So we haven't seen it getting worse as of right now, Lawrence. I would say we are seeing a flattening of the curve. But I'm sure as you go area by area, depending on where local lockdowns are happening, they'll have an impact. But we haven't seen that yet at our level. So we are seeing more of a flattening. But this thing can change weekly depending on how it goes. So this is just an initial trend of what we're seeing right now.

Thank you very much.

Thank you. That 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.

All right. Thank you. To wrap up, our operational performance was strong in the third quarter as we executed well, innovated for our customers and continued to fight the pandemic from all angles. In a highly uncertain economic environment, our team delivered robust cash flow, strong margins and returned to positive organic sales growth. Looking ahead, we will continue to invest in both growth and productivity. And we remain confident in our ability to lead the economic recovery, deliver great value for our stakeholders and realize new opportunities from emerging market trends. 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.