3M (MMM) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the 3M third quarter earnings conference call. (Operator Instructions) 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 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 Patolawala, 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 will make certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-Q 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 a significant improvement sequentially in trends versus Q2 across businesses and geographies, and we returned to positive year-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 health care workers and the public, while 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 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 confident 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 5.

Company-wide total sales increased 5% year-over-year and 16% sequentially to $8.4 billion, slightly above our estimates. 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 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 remain down year-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% organically, with strong growth in personal safety, consumer and health care. EMEA was flat versus down 15% in Q2, while 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 while returning $2.5 billion in dividends to shareholders through the first 9 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 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, 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 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 2 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 7. Company-wide, third quarter sales were $8.4 billion, up 4.5% year-on-year, with 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 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 Acelity acquisition due to purchase accounting impacts.

Operationally, Acelity delivered a solid third quarter as health care elective procedures picked up sequentially. Based on Acelity's first year performance and integration progress, we are confident in the long-term success of this business.

Please note that Acelity 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 8 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 $0.15 year-on-year earnings decline is primarily due to 2 items: first, as discussed on the prior slide, the Q3 2019 $58 million real estate gain resulted in an $0.08 per share earnings headwind year-on-year; and second, our third quarter adjusted tax rate was 21.4% versus 19% last year, resulting in an $0.08 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 $0.01 to earnings.

Please turn to Slide 9 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 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 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 6.9% 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 remain 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 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, which was partially offset by year-on-year weakness in consumer electronics, particularly in smartphones.

Our auto OEM business was down 4% year-on-year compared to the 3% decline in global car and light truck builds. Year-to-date, our automotive business has outperformed global builds 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 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 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 health care 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 health care workers.

Excluding the respiratory impact, this business declined low single digits as elective procedures remain significantly below 2019 levels. Our oral care business returned to positive growth in Q3, up 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 year-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 remain cautious relative to the 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, Health Care's third quarter operating margins were 23.5%, down 320 basis points year-on-year. Margins were negatively impacted by the Acelity 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 Filtrete air filtration products, ScotchBlue Painter's Tapes, Command wall hanging products, Meguiar's car care products and Scotch-Brite cleaning products and solutions.

Stationery 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%.

Consumer's 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 health care 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 fewer 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 2 fewer business days in Q4 as compared to Q3 this year.

As we have done over the past several months, we will provide a 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, 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 3Mers 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.

(Operator Instructions) Our first question comes from the line of Deane Dray from RBC Capital Markets.

Just 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 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 -- size the biggest outliers on both sides of that equation and how you think that nets out as you see it today?

Yes. 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. But half of 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. 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.

I would just add, Dean, I think the other piece is we've also hit on elective procedures. So they are also down year-over-year. So that impacts our health care 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 our semiconductor space, data centers, factory automation is another area of strength that has helped us and through COVID.

Got that. And then as a follow-up, when I looked at the guidance that you had given or the 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 4Q. But just if you -- 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?

Yes. 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. There's -- 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. We've -- 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 has 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 4]. As you know, through the pandemic and through the uncertainty that's going on, we have strengthened the 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.

Our next question comes from the line of Scott Davis from Melius Research.

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 has 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 has 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 year-over-year basis as we bought Acelity 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 price in the quarter that you quoted in the earlier slide, I think, 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 price. Is 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 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? Just maybe some high-level commentary there would be helpful.

Sure, Scott. Price was 60 basis points, and I agree with you, the team has 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 have 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.

Our next question comes from the line of Nigel Coe from Wolfe Research.

I'm just kind of curious on the sequential trends, and obviously, you've given some decent information on what you've seen in October. But it does seem like on a daily sales basis, September was a bit weaker than what you saw in July, August. And maybe October got a little bit better than September. I mean, again, I don't want to sort of play the [interest] here, but can you just make comments, number one, if that's kind of correct on a daily sales basis? And then secondly, what you're seeing in terms of channels by business, if possible. And kind of did we see a big restock through the summer that perhaps has now played through? Any information on that would be great.

Yes. 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, we came in a bit better than the range that we said, the $8.2 billion to $8.3 billion. Overall, revenues were pretty consistent through the quarter. 2 months, we had sales, we were up about 4%. For the full quarter, we grew about 4.5%. 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 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 off-line with Bruce on that. And then my follow-up question is on inventories. You've taken down inventories a fair bit into -- from 2Q to 3Q, I think, down roughly $200 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. 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 probably 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 2 pieces that drove it. One is you saw the volumes quarter-over-quarter sequentially, up nearly 16%. I would say that's just #1 that drove it. And secondly, the team has been focused and is focused on driving inventory velocity up. And those are the 2 factors. For example, they started doing -- using a lot of data and analytics that helps us decide where our inventory level 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 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 level should be, what our inventory level 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 manufacturing unabsorbed cost. So as you know, some lines were up or down. We have incurred costs, which is approximately $35 million of fixed cost that are unabsorbed manufacturing variances.

Our next question comes from the line of Andy Kaplowitz with Citi.

Monish, maybe you can give us a little more color into your adjusted operating margin guidance, the 21% for Q4. You obviously recorded a much higher margin than that in Q3. Incrementals were good sequentially, above 40%. Obviously, we know 2 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?

So I would say, Andy, there are quite a few factors that go into it, so I'll just start again with just with the uncertainty that's in the market, and volume is a big driver of it. We are seeing GDP and IPI, both are going to be down year-over-year or projected to be down.

We have 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 have cost -- 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 2 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, Monish. And then maybe just a follow-up on that. Can you give us more color into the margin performance in Safety and Industrial and Consumer. The margins you recorded in 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 sort of tailwind that you're seeing is from some of the long-term things you've been doing like business transformation, factory optimization? 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 2 segments and 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 about the future. On the growth in SIBG, the margins were driven by 2 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 and 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.

Our next question comes from the line of John Walsh from Crédit Suisse.

So wanted to go back to kind of the capital allocation strategy. If we take where you ended this quarter after some delevering actions 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 1.5 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 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-2 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 we're 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. But you should just count on 3M to have a strong balance sheet, and that's what we're going towards.

Got you. 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.

Yes, 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 bellwether trials in Michigan or the multi-district litigation actions, those are coming now sometime early to the first half of next year. So nothing more. We -- the reserves that we've taken for the work that we've been doing on our manufacturing sites. Those are -- those cover what we see as probable and estimable today. So that gives you kind of an updated outlook into early next year.

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

Nice sequential improvement on Health Care, but sort of longer-term question. This used to be 28%, 30% margin business. Or another way to ask is, in 2017, 2018, you could make around $500 billion with $1.6 billion, $1.7 billion of revenue and now sort of takes $2.2 billion of revenue to make that. Can you just bridge the gap, where we were and where we are now. And I get that Acelity is 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?

Yes, Andrew, this is Bruce. If you look at the EBITDA margins of Health Care, they're right at 30% here in the quarter. So the big driver of -- there's 2 items really that impact margins as you look at it historically. The realignment of the company when we move the Separation, Purification business into Health Care had below-average Health Care margins. So that had a negative impact. And then secondly, the D&A associated with the Acelity acquisition is impacting the margins. So peeling that back, though, Health Care right now is right around 30%. So kind of back to the upper 20s to around 30% range.

Got you. And then the second question is on elective procedures, you sort of did -- I think you sort of indicated a slowdown in September, October. Can you just comment as to what explicitly you guys are seeing 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 Health Care and across the board for the company?

Yes. 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. That was behind some of the improvements that you saw sequentially in the Health Care business broadly. We -- as Monish mentioned in his remarks, we've seen a flattening of elective procedures, not necessarily a downturn or -- but a slowdown and a flattening as we've exited September and come into October. So back to its -- 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 -- sorry, go ahead.

So are you effectively modeling no acceleration -- 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 U.S. and Europe with the data that we see, Andrew, was, at the end of third quarter, between the 70% to 75% of pre-COVID levels in those 2 parts of the world. China, of course, was a little higher in between the 85% to 90%. And as we said, I think what we are seeing is a flattening. I think there's nervousness right now with some of -- with 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 are seeing is pretty much flat, October to September.

Our next question comes from the line of Joe Ritchie from Goldman Sachs.

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 3Q? And is there still any kind of carryover benefit from those cost actions that we should expect into 4Q?

Sure, Joe. I'll answer both separately. On the $400 million, as announced and 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 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. 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's helpful, Monish. And then just 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 looks like we're going to be in this pandemic-related situation for quite some time. I guess 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?

Yes. The way we look at it, Joe, is that we believe respirator 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 million to 2.5 billion respirators for 2021. And so our view is that demand remains strong. As well as 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.

Our next question comes from the line of Julian Mitchell from Barclays.

Maybe just hopefully for you, at least, one last question on Health Care margins. So 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 I understand the Separation and Purification going into the segment, I understand the Acelity impact. But you look year-on-year, Q3, the margin ex-Acelity is still down 100 bps 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 Health Care? 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'd 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 volumes going to be based on where we are with everything that we're seeing in electives and 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, Monish, circling back on that cost question that Joe had touched on. If we look at, say, 2021 in aggregate with everything that we know today, you've got 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 costs coming back? Or those all came back in the second half of this year already?

Yes. So 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. And 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 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, 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 be investing 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 we'll definitely keep you appraised of that as soon as we lock down on our case.

Yes, 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.

Yes, yes, my fault. Yes, my apologies. That's right.

Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley.

So just to move 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 1 billion of these things a year on a run rate basis. And I would suspect that 3M probably making it cheaper as 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 deployment? Because I think going hand-in-hand with needing masks for a while is we're probably going to need tests for a while, too.

Yes. 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 it's -- 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 test 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 in the first half of next year, just to give you a little bit of the time line. But it is something that would be a volume-based, low-cost test that could be used broadly. So it's -- 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 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 $5 to $10 a test. Is this -- sounds like you'd be on the lower end of that, maybe a little bit lower, but the easy algebra there, it comes over the pretty big revenue number if all that comes together. Is that that fair but still just too early to commit to a total (inaudible)?

Yes. 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.

Our next question comes from the line of Steve Tusa with JPMorgan Securities.

Just wanted to confirm. So October kind of if you adjust to days sales, like up 5 or something like that. Is that kind of the right number adjusted for days?

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

Okay. Got it. Got it. Got it. Sorry, I might have missed 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 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 our planning for '21, we'll definitely keep you posted. But as of right now, nothing mechanical.

Yes. On pension, 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 snap the line today, where would that be?

We're not providing that at this point, Steve.

Our question comes from the line of John Inch from Gordon Haskett.

Yes. By the way, I see on Page 11, you're really bullish on general cleaning. So can I ask you, 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, 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 million to $120 million, a 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 when you add back the restructuring costs, you get 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. Just trying to get back to the -- like to gauge how conservative you're being in terms of your fourth quarter guide of 21%.

Yes, there is 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 modification during the holiday. So -- plus we're continuing to making sure we're investing in the business to set up success as we go into 2021. So for now, 21% is where we think is appropriate as we start the quarter.

Okay. And then just secondly, where do you expect COVID sales to be in the fourth quarter versus the $235 million in the third quarter? In other words, sort of how much up 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 sort of -- what's happening to the curve sequentially in terms of the contribution, if you can maybe isolate that.

Yes, 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 will have a little bit of an impact. I think it's still in that 300 basis point range for Q4. It's -- it will be sequentially up slightly off of Q3.

Sequentially up slightly even though the fourth quarter is usually a bigger sales number, though, right? No, I'm not [quoting]. And I'm just trying to understand the context. It seems like it's holding steady.

Yes. Normally, you see a sequential decline from Q3 to Q4. Really, typically, there's 2 days difference between Q3 and Q4. That's one of the drivers. It's -- there's 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 phenom, 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 then we're bringing that capacity on to be ready for that. Well, as Monish 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 on that.

Our last question comes from the line of Laurence Alexander from Jefferies & Company.

It's (inaudible) on the line for Laurence, 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 the recent weeks just with all the headlines we're seeing with increasing COVID cases worldwide, if things are getting worse in that particular subsegment.

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 we are seeing more 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.

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 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.