Q3 2020 3M Co Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the three M. <unk> third quarter earnings Conference call.
During the presentation, all participants will be in a listen only mode.
Afterwards, we will conduct a question 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.
Tuesday October 27 2020.
I would now like to turn the call over to Bruce Jermeland, Vice President of Investor Relations at three am.
Thank you and good morning, everyone welcome to our third quarter 2020 business review.
With me today are Mike Roman Threems, Chairman and Chief Executive Officer.
Along with more niche, but all the while our chief financial Officer.
Mike in Modish 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 Web site had three M dot com under the heading quarterly earnings.
Please turn to slide two.
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 three.
During today's conference call, we will make certain predictive statements that reflect our current views about three m. <unk> 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 one eight of our most recent form 10-Q list.
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 four 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 a significant improvement sequentially in trends versus Q2 across businesses and geographies and we returned to positive year over year organic growth.
Well, we remain in a highly uncertain economic environment. It is a credit to our team that three m. continues to execute well deliver value to our customers and fight depend damage from every angle.
We continue to prioritize protecting our employees frontline health care workers and the public well supporting the reopening of economies around the world.
We have distributed 1.4 billion respirators year 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 continued to add capacity.
Three m. 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.
So 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 confident in our ability to lead and the economic recovery as we take actions to transform three and realize new opportunities from emerging customer needs and global market trends.
Please turn to slide five.
Companywide total sales increased 5% year over year, and 16% sequentially to $8.4 billion slightly above our estimate.
With respect to organic sales, we delivered growth of 1% year over year with adjusted earnings of $2.43 per share.
In the third quarter demand remains strong and personal safety along with areas such as home improvement data centers and Biopharma filtration and.
And we see continued momentum in these end markets into October.
Well, we saw improvement in other end markets versus the second quarter, many remain down year over year, including health care elective procedures auto OEM and general industrial.
Geographically, we experienced notable improvement in the Americas.
By the U.S. up 5% organically with strong growth in personal safety consumer and health care.
EMEA was flat versus down 15% in Q2.
Well Asia Pacific was down 3% organically.
We delivered growth of 8% in China with all business groups above 6%.
Offset by Japan, which continues to be challenged.
Our execution was strong as we posted adjusted EBITDA margins of 29% with all business groups at or above 27%.
Our adjusted free cash flow increased to $2.2 billion in the quarter.
Year to date, we have expanded cash flow by 19% 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 well.
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 remained cautious we will stay focused on serving our customers driving operational improvement and investing for the future. Please.
Please turn to slide six.
Over the past several months customer and stakeholder trust in three M. 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 three M. 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 filtrete portfolio to introduce new innovative products and create additional capacity.
As a result, our air quality platform has grown double digits year to date, as we keep families healthier and more productive.
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 three.
At the same time end markets like office, hospitality and oil and gas have been highly impacted by cold in 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 clear from.
From our ability to deliver a threefold 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 to new respirator lines at a plant in Sheboygan Falls, Wisconsin approach.
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.
Enable us to deliver greater value for our customers shareholders and all stakeholders as economies recover from the impact of cold at 19.
That wraps up my opening comments and I'll turn it over to Mona is 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.
Please turn to slide seven.
Companywide third quarter sales were $8.4 billion up 4.5% year on year.
Adjusted operating income of $1.9 billion in line with last year.
Third quarter, adjusted operating margins were 22.9% versus 23.8% last year.
As the company disclosed and you may recall.
We recorded a 58 million dollar 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 this year's third quarter, our ongoing cost management and productivity efforts 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 DSL. It the acquisition due to purchase accounting impacts.
Operationally esselte delivered a solid third quarter as healthcare elective procedures picked up sequentially.
Based on facilities first year performance and integration progress we are confident in the long term success of this business.
Please note that a Saturday 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 cents year on year earnings decline is primarily due to two items.
First as discussed on the prior slide the.
The Q3 2019 $58 million real estate gain resulted in an eight cents per share earnings headwind year on year.
And second.
Third quarter adjusted tax rate was 21.4% versus 19% last year.
Resulting in an 8% 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 one cents to earnings.
Please turn to slide nine for a 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.
Up 13% year over year.
The third quarter cash flow performance was driven by a significant improvement in working capital, which contributed over $330 million of cash.
Of 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 billion 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 and but I had to summarize the business group performance for Q3.
I will start with that safety and industrial business.
Which posted organic growth of 6.9% year on year in the third quarter.
Personal safety posting 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 in 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 unmasking systems a.
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 macroeconomic uncertainty.
Looking geographically.
The Americas grew 11% organically, but the U.S. up low teens.
Let me also grew 8%, while Asia Pacific was down low single digits.
Safety and industrial 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 7.1% organically compared to last year.
Our electronics related business was up 1% with continued strong growth in semiconductor factory automation and data centers.
We just partially offset by yield on your weakness in consumer electronics, particularly in smartphones.
Our auto OEM business was down 4% year on year.
Back to the 3% decline in global car and light truck builds.
Year to date, our automotive business has outperformed global bills by approximately 400 basis points.
Beyond automotive builds 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 year on year organic sales declines in our commercial solutions transportation safety and advanced materials 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 was partially offset by continued cost discipline.
Turning to health care.
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 health care business delivered Q3 organic sales growth of 8.1% year 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 remains significantly below 2019 levels.
Our oral care business returned to positive growth in Q3.
Up low single digits organically.
Going 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 covered levels through the end of 2021.
Our separation and purification business increased low teens year on year.
This business continues to experience strong demand for Biopharma filtration solutions in support of the Pharmaceuticals industries research and manufacturing efforts to develop vaccines and therapeutic treatments for coal would.
Turning to health information system.
This business declined mid single digits organically in the quarter as hospitals remain cautious relative to the information technology investments.
And finally for safety declined low single digits.
As the pandemic and related prevention protocols continued 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 third quarter operating margins were 23.5% down 320 basis points year on year.
Margins were negatively impacted by the affinity 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 homecare businesses.
Each up low double digits organically.
Growth in these businesses was driven by strong customer demand for our filtrate air filtration products.
Scotchblue painter's tapes.
Command wall hanging products.
Mcguire car care products.
And Scott bright cleaning products and solutions.
Stationery and office declined double digits as a result of many business offices and schools is 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 entered the fourth quarter significant economic and end market uncertainty continues to persist.
As both global GDP and IP 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.
Improvement.
Andrew 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 covered 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 fuel business day year on year.
Please note.
Relative to business days that there is no yield on your the 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.
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 by Q4 total sales growth.
And as a reminder, we will have a negative fourth quarter sales impact year on year of approximately $100 million 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.
I would like to thank all three Emerson for the hard work this quarter and the progress that we have made.
In the spirit of continuous improvement there is 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 to daily management.
With that I. Thank you for your attention and we will now take your questions.
Thank you.
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Please limit your participation to one question and one follow up.
One moment, please while we compile the Q and a roster.
Our first question comes from the line of Deane Dray from RBC capital markets. Please proceed with your question.
Thank you good morning, everyone, Hey, Deane.
I mean it would.
With respect to the precision that you can provide and have been providing on the contribution from respirators is it possible to give a take a stab at that net coal that impact across three or maybe the size like the key part.
Positives and negatives and positives I would imagine there are other pp and the home improvement trends and so forth.
If you could not that size.
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 a COVID-19, we talked about respirators bought 300 basis points of growth impact on the enterprise.
From that demand that we're seeing and respirators bought half our businesses do remain down year on year. So we highlighted a couple of 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.
If you look at some of the ones that have been impacted negatively our office markets.
I would say are in our hospitality kind of the commercial solutions. Those are both down low teens. So kind of gives you a view of how the impact plays out on both sides of that both the positive demand in some of the impacts negatively from Cowen.
Hi, good Justin I would just add Deane I think the other pieces. We've also hit on elective procedure. So they are also down year over year, so that impacts our health care business and then on the positive side to the other piece that will throw out is as the economy moves toward digital first thinking about how we play in a semiconductor space data.
Sanders factory automation is another area of strength that has helped us in improving.
Got that and then as a follow up on that.
When I looked at the guidance that you had given.
The framework for the third quarter, and you came in pretty darn close to and actually above on revenues and above on margins.
What.
The prospects for restoring guidance.
I know you've given our framework for for Q, but just if you are in the position we are pretty darn close.
At this stage when might guidance be restored and when might you restore buybacks I mean, you commented on disciplined capital allocation.
But you had really good cash flow you paid down debt when might buybacks be restored. Thanks, Yeah de 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.
Oh it how the economy is going to impact the business as we were just talking about and that remains true today, there's within the current environment remains uncertain. So we will continue to keep our guidance withdrawn we're going to.
Focus on executing well against what we see coming and and we'll continue to report monthly sales as soon as we get better visibility.
Of the market outlook and the trends and we will look at bringing back view of guidance, but for now we'll we'll stay with the monthly sales reports.
And as I go to capital allocation Dean just our priorities haven't changed we have what we have 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 as a been a hallmark of three m. and I know our investors care about it so thats, our second priority and that our third.
Priorities M&A and then but that is share buyback. So that's that's the way we look at for 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 a 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 see.
Thank you.
Our next question comes from the line of Scott Davis from Middle East Research. Please proceed with your question.
Hi, Good morning, guys, Hey, Scott.
I'm not.
Are you guys surprised at all that health care margins weren't a little bit better just given the 8% growth.
The operating leverage that you would typically get from that.
No I think I would say Scott we are 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 have seen so.
Nothing nothing untoward. The thing that you also have to keep in mind on a year over year basis, as we bought back a salad and the impact of the purchase accounting nearly causes a 220 basis point drag on a year over year basis due to purchase accounting.
Yes, I saw that so.
Okay I'll move on the.
The price in the quarter.
That you quoted in the earlier slide I think 60 basis points I believe that's a pretty good number.
Number in a recession.
Particularly given that raw material costs are our lowest it's not pushing up prices that is there any way to kind of tease that out is that.
New product and so therefore, it's kind of partially price mix is that.
Is it just the fact that there's certain products you have that are really high demand right now and so youre getting price in that area as or just maybe some high level commentary there would be helpful for.
Sure Scott a price was 60 basis points and I agree with you. The teams 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 60, I would say the Americas and the EMEA able boat that we saw price increase.
Asia Pacific was down on year over year.
And I would say there is nothing I would call out a specific on one product line that drove it it's a general incur.
Increase that we've seen across multiple markets and the products that we've 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. Thank you. Thanks, Thanks guys.
Thank you.
Our next question comes from the line of Nigel Coe from Wolfe Research. Please proceed with your question.
Thanks, Good morning.
Hi, Nigel yes.
Hi, I'm just kind.
Kind of curious on the sequential trends and obviously given some some some decent information on what we've seen in October but.
But it does seem like on a daily sales basis, Tim was a bit weaker than we saw in July August and maybe October.
October got little bit better tens I mean, again I don't want to play the answers here, but.
Can you just make comments on them. One is if that's correct on a daily sales basis, and then and then secondly, what you've seen since the channels.
Bye bye bye business as possible and kind of did we see a big restock through some of the professional fees through any any information would be great.
Nigel maybe I'll start with the second part of that just looking at the channel we havent seen strong restocking across most of our portfolio, maybe some in health care as elective procedures have come back.
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, we came in a bit better than the range that we said 8.2 $8.3 billion.
Overall revenues were pretty consistent through the quarter two months, we had sales we were up about 4% for the full quarter, we grew about 4.5%.
Normally I would say pre covered 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 want more Nash 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 through the interim quarter of Q3 into the start of Q4.
Okay, great well follow up offline with that with Bruce on that and then my follow up question is on inventories you taking down inventories.
Bits into from Twoq to Threeq, I think down roughly $20 million.
Implies that your production volumes were down 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 I'm just wondering if there was a drag from the inventory reduction.
Then you can do you expect to continue reducing inventories and two for Q3 two one.
Sure.
Start with the 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 that team has been focused on is focused on driving inventory velocity up and those are the two factors. For example, they started doing 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 on do you see it going down or not I think our philosophy hasnt changed on making sure that our inventory levels keep going down in a 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 talked about touched about some of the lines.
Where we were down double digits and some other lines by Veeva way up double digits. So I think thats, 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 him.
Moving.
And then your last question on on manufacturing Unabsorbed cost. So as you know some lines were up or down we have incurred cost, which is approximately $35 million off of fixed cost that our unims off manufacturing variances.
I think I got five questions. So I'll leave it there thanks very much.
[laughter].
Thank you. Our next question comes from the line of Andy Kaplowitz with Citi. Please proceed with your question.
Hey, good morning, guys.
Hey, Andy.
Let me maybe you can give us a little more color into your adjusted operating margin guidance to 21% for Q4, you obviously recorded much higher margin than that in Q3 Incrementals are a good sequentially above 40%, obviously, we know two fewer selling days due to lower sales, but is there any other margin impacts on the business in Q4 versus Q3.
And mix or maybe you expect temporary cost to come back faster in Q4.
Yes, so I would say Andy a cup that quite a few factors that go into that to start again, but just with the uncertainty that's in the market.
And volumes a big driver of it we are seeing GDP and ipi both are going to be down year over year are projected to be down. We have also seen uncertainty in the market in general.
We are seeing places where for example, what I said healthcare procedures, a leveling customers the remaining cautious.
Et cetera, so there's a lot of uncertainty in that market on the flip side, we continue to see a pretty good end market trends, whether it is on our personal safety a 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're continue.
Going to focus on.
Making sure that we have a cost we are being very cautious on cost us but at the same time, we will invest in growth and productivity were 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 to Q3 versus Q4, we always see a drop in margins Q4 is the lowest for the three M.
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.
Shorter number of days, so with all that put together, we believe right now the line of sight, we have is 21%.
That's helpful Nation, and maybe just to follow up on that can you give us more color into the margin performance in safety and industrial and consumer.
Margins you recorded in Q3 in both those segments, we really haven't seen those kind of margins from three I'm in those segments. So maybe the sustainability if temporary costs come back how much of the sort of tell when that you're seeing is from seeing some of the long term things you've been doing like business transformation factory optimization I think you mentioned advertising may.
If you're doing less advertising consumer, but do you see these types of margins being sustainable as you go forward in these two segments and as you go into 21.
Sure I'll start with just giving you the reasons for for those strong growth and then I'll talk about the four to be thing on the future on on the growth and ESI BG. The margins were driven by two pieces. One is extremely strong demand for our foot on 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. So safety industrialist continued to invest also where we see the growth opportunities.
And then on the consumer side, it's driven again by strong growth in in our home care business and a 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.
GAAP 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 are going to follow which is we're going to invest in growth and productivity in areas.
We feel that has long term potential for three m. at the same time will dial back in areas of Reprioritize in areas that we feel.
In the short run Menard to give us the big Bang for the Buck. So that's the way we would think about it.
I 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, Hey, John Hi, John.
Hi.
So wanted to go back to kind of the capital allocation strategy.
You know, we take where you ended this quarter after some de levering actions.
I'll use consensus numbers here, but you take what your forecasted for free cash flow less the dividend you look at the EBITDA projections I mean, theres a past here for you and next year below one and a half turns of net leverage.
Is that where you're trying to get too would you push back on any of that I just wanted to get your thoughts on where you actually want to get the net leverage down to.
Sure John.
As Nick and Mike said before my time to 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 1.8 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 would be going other than we want to keep strengthening the balance sheet keep giving us the financial flexibility and that's what we are 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.
You should just count on three M. to have a strong balance sheet and thats, what we are going towards.
Got you know thank you for that and then just thinking about some of the uses of that potentially.
Any update here around environmental thinking about an EPA action plan and or anything on the calendar just for investors to be aware as we think about what 2021 looks like I think you provided an update last quarter was just curious if anything changed.
Yeah, John maybe I'll start where we always start we're proactively managing that really yeah, chessen PFS kinds of.
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 yes, weve been supportive of the EPA is.
Planned for managing people.
PFS and we have been working in support of them with our commitments to provide a clearing house of information around that when you look at how do we look at 2020 and 2021 I would say we continue to work.
As three m. around our manufacturing sites around historical disposal, and we continued to make progress on that.
When you look at potential other actions and other E Hs matters I would.
I'd say there has been.
A slowdown with some litigation actions as part of that in the middle of covert. So now we're looking at trials and related matters next year first half of next year, So whether it's a bellwether trials in Michigan or or the.
The multi district litigation actions overcoming now it's sometime early so first half of next year. So nothing more we are the reserves that we've taken for the work that we've been doing on our manufacturing sites and those are those cover what we see as probable and estimable today. So it. So thats gives you kind of an updated outlook.
Into early next year.
Great I 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.
Hi, Andrew.
Nice sequential improvement on health care, but sort of longer term question.
This used to be 20, a 30% margin business.
Or another way to ask it in 2017 2018, you can make around 500 billion was 1.6 $1.7 billion of revenue and now sort of takes $2.2 billion of revenue to make that can you just bridge the gap.
Well, we were and where we are now and I just had a solid is 200 basis points plus but what are the other big buckets.
That's sort of drive this decline in margin and what would it take for it to come back.
Andrew This is Bruce.
If you look at the EBIT margins in healthcare there right at 30% here in the quarters. So.
The big driver of Theres, 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 health care had below average healthcare margins. So that had a negative impact and then secondly are.
The DNA associated with facility acquisition is impacting the margin so.
Peeling that back, though health care right now is right around 30% so.
Kind of back to the upper twentys to around 30% range.
Gotcha.
And then the second question is on.
I'd like to procedures, you're sort of that.
I think you sort of indicated slowed 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 way of Cove. It and how is the second way of covert factoring your forecast for healthcare in across the board for the company. Thank you Andrew just to.
If you look at Q3, we saw an increase in elective procedures coming into Q through 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 health care business broadly, we as management mentioned in his remarks, we've seen a flattening of electric procedures, not necessarily a a downturn or but it's a slow down in a flattening as we exited September and come into October so back to it it's what what's driving it.
There is a lot of uncertainty of will it picked back up will it stay flat I would say we are continue to remain cautious there as well.
So just.
Sorry, sorry go ahead.
So are you effectively modeling.
No acceleration no sequential acceleration in elective procedures due to covert is that just part of the framework.
So just first answer a little more on that number so if the us and Europe at the data that we see Andrew was at the end of third quarter between the 70% to 75% of pre corporate levels.
In those two parts of the World China of course was a little higher in between the 85 for the 90%.
And as we said I think what we are seeing is a flattening I think there is nervousness right now with some of that what's going on in the world of course with the outbreaks of call. It 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 are seeing is pretty much flat October to some.
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 Hey, Joe.
Hey, So my first question is maybe just focused on the.
Absent that you had announced previously I think you had announced something like 400 million or so and 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 how did those play out into Threeq you and is.
Is there still any kind of carryover benefit from those cost actions that we should expect into fourq here.
Sure Joe So both separately on the 400 million as 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.
P. accruals become negative quarter over quarter. The overall impact of all that put together was a 50 million dollar benefit in Q3.
And then your second question on what do I see it 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.
Then in the fourth quarter of 2019, all Soviet announced actions that we've taken as we went into the new model of trends the new transform way of running three m. and there's approximately $30 million of benefit in that in the second half.
Okay, Alright, Thats helpful. Nice and then I just my one follow up question I know, it's probably too early to start thinking about 2021, but.
You do have this this phenomenon this year.
Yes, where you're you're respirator sales are helping to boost growth in 2020 and.
It looks like we're going to be in this yes. This pandemic related situation for quite some time I guess I'm just trying to understand how you guys are thinking about framing.
While the either tailwind or headwind could potentially be in 2021 from from just a respirator portion of your business.
Yes, the way we look at it.
Joe is that we believe respirator production continues that demand continues for a long time. So we continues to see I would say this trends from that business.
To grow we are investing in capacity as we have announced we have made.
Around will be anchored 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 soul.
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 to home filtration products.
Three m. as is doing everything we can to help the world out and make it safer.
Thank you I'll get back in queue.
Thank you our next.
This question comes from the line of Julian Mitchell from Barclays. Please proceed with your question.
Hi, good morning.
Morning, Joe maybe just good morning, let me and hopefully for you at least one one last question on healthcare margin. So.
Yes, 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.
To stand the separation and purification going into the segments on the stand the SLS the impact.
But you look year on year Q3, the margin accessibility is still down 100, bips so of high single digit organic growth.
And I understand sequentially the margin was up in Q3.
I'm guessing, it's probably down sequentially in Q4.
Just wanted 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 that might kind of outsized reinvestment needs there.
So I'll answer my question Julian with the caveat that 90 days in but I'd I'd start with the following that the team has done a nice job you saw the the quest 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.
The volume is going to be based on baby are with everything that we are seeing and electives and oral care and I think thats. The big piece that 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 a pandemic, we will not allow.
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 the Nash.
Circling back on that cost question that Joe had touched on if we look at say 2020 one in aggregate.
With everything that we know today.
Some fixed costs I suppose carryover savings from the Q2 actions 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 sit today from temporary cost is coming back.
So we 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 the tailwind of nearly $110 million in.
2021, because that's the restructuring action that will 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 et cetera, 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 we will be invest in growth and productivity at the same time. So long answer to your question that there are multiple moving pieces we are in.
In the midst of working through 2021, and we'll definitely keep you appraised of that as soon as we locked down on our case yeah Julian.
Julian just let me clarify to the actions we took the $110 million related to our Q4 action we announced.
Q2 action, we announced is relatively small.
Yeah, My apologies perfection.
Great. Thanks, Manish and Bruce Yes. Thank you.
Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please proceed with your question.
Hi, Good morning, guys, Hey, Josh.
So just to have a little bit off the current quarter and Mike you touched on it a little bit in your opening remarks, I just want to dig in a little bit more.
This lateral imaging tests that you are putting together with MIT.
I'm reading this right and some of your peers are out there making billion of these things a year on a run rate basis, and I would suspect that OEM, probably making a cheaper as more of a professional manufacture than some of these other folks.
And given that the mediums you're working with.
How big could this be.
Is this something thats any closer to to deployments I think going hand in hand with meeting masks for a while is we're probably getting the test for a while too.
Yes, Josh let me give you maybe an update here. So this is the 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 our 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 we.
Created a prototype of that and its a this is a saliva based test and we've demonstrated sensitivity in the lab and were currently in a phase where it's being validated by an outside laboratory and this includes.
Number of a series of tests, including test again saw alive samples positives negatives really to determine how good it is as 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 in the first half of next year to give you a little bit of a timeline, but it is something I would be a follow.
Volume base LOE costs.
Tests that could be used broadly so it's we're excited about the partnership were excited about the.
Good progress to this point, but more work to be done.
Got it and just so I'm understanding that the numbers right, maybe those that run rate production number that throughout sounds like it's not too far off but price per test.
Those peers are five to 10 Bucks a task this sounds like you'd be on the lower end of that maybe a little bit lower by.
The easy algebra, there comes up with a pretty big revenue number if all that comes together is that that fair, but still just too early to commit to kind of adjust Pam yes, Josh we still have some work to do side I'll stay with low cost for now and we'll come back as we make more progress.
Got it perfect and I see overtime were over time and I appreciate the color so I'll leave it there.
Okay shares.
Our next question comes from the line of Steve Tusa with Jpmorgan Securities. Please proceed with your question.
Hey, guys. Good morning. Thanks.
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 adjusted for days.
Well as we Steve we said, it's lower flat to low single digits October trend that takes into account that extra day, so trying to get a little bit above that net of the extra got it got it sorry, I I might have missed that and then.
Just a it just kind of like headed into next year.
On on the top line.
And any kind of major sorry.
Sorry on the bottom line and any kind of puts and takes that we have to be aware of when it comes to pension or anything like that that's just more mechanical when thinking about next year.
Nothing that I can think off right now Steve again, as we get through 21, we'll as we finish our planning for 21, we'll definitely keep you posted but as of right now nothing mechanical yeah on pension Steve Obviously, we'll see where rates are at on December 31, and that will determine what the expenses next year.
Where would that if you snap the line today, where would that be.
We're not providing at this point Steve Okay.
Okay, great. Thanks, a lot guys yep.
Our next question comes from the line of John inch from Gordon Haskett. Please proceed with your question.
Yes. Thanks, Thanks for squeezing me and good morning, everybody Hey, John.
Morning, guys by the way I see on page 11, you really bullish on general cleaning.
[laughter].
So can I ask you what was the.
What were the third quarter 20 margin benefits of past restructuring actions.
If we could just perhaps start there.
Yes, if you look at third quarter, John is pretty minimal because we've lapped now the Q2 actions, we took a year ago.
Hi Inn in the Q4 actions that we announced earlier this year.
They were somewhat impacted by coded.
Hi Inn, so we put in place for example, things like hiring freezes as we've gone through coded.
So those actions are going to have more of an impact next year's Munish mentioned 110 to 120 million.
Little impact here in the second half of this year.
Okay. Bruce So then I mean to get to 21% margins for the fourth quarter. If you look a year ago and you add back the restructuring costs, you get a kind of almost 21% so you're sort of assuming kind of flat pro forma margins. I was just wondering if you expected contribution from any kind of.
Cost out tailwinds or other things I'm, just trying to get back to that like to gauge how conservative you are being in terms of your fourth quarter guide and 21%.
Yes. There is there is some benefit from the actions we took that as more niche mentioned earlier, John some of the actions that we've 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 continue to making sure we are investing in the business to set up success as we go into 2021 so.
We're now at 21% is where we think is appropriate to be as we started the quarter.
Okay, and then just secondly, what do you expect cobot 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 up those numbers 1.4 to 2.4 or five next year, but what sort of what's happening to the curve sequentially in terms of the contribution if you've been to weaken.
We could maybe isolate that thanks, yeah. John So we are we finished mentioned we've added capacity as we've come into the second half are brought online capacity that we had been working on as we've gone through the year. So that will have a little bit of an impact I think it's still in that 300 basis point range for Q4, EPS 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 not willing and just I'm just trying to understand the context of the country normally yes.
It's holding steady normally you see.
Sequential decline from Q3 to Q4 really typically theres two days difference between Q3 and Q4, that's one of the drivers. It's there's the holidays have an impact on so we.
In respirators 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 sort of the demand out there.
And then Mike moving into 2021, do you see covidien sales sort of gently decelerating or do you see more of a like.
Like a bit of a cliff phenomenally 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 will as Warner said, we're getting that kind of our view of this as we get further into Q4 and get ready for 2021 will come back and give you a breakdown on that.
Good stuff, thanks very much.
John.
Our last question comes from the line of Laurence Alexander from Jefferies and company. Please proceed with your question.
Hi, guys its centers over the long lines to launch just a quick one.
Hello Electric demand has been weak because obvious reasons I was wondering if that has accelerated in recent weeks just with all the headlines we're seeing increasing cold cases worldwide. If things are getting worse in that particular sub segment.
So we haven't seen it getting worse as of right now Laurence 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 if you think about a flattening.
But this could things can change quickly depending on how it goes. So there is this is just an initial trying to what we're seeing right now.
Thank you very much.
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.
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 and a highly uncertain economic environment. Our team delivered robust cash flow strong margins and return 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.
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