3M (MMM) 2014 Q2 法說會逐字稿

Welcome to the 3M second quarter earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded, Thursday, July 24, 2014.

I would now like to turn the call over to Matt Ginter, Vice President of Investor Relations at 3M.

Good morning everyone, and welcome to our second quarter 2014 business review.

I have a few announcements before we begin today's business discussion.

We will hold our next investor meeting on Tuesday, December 16, at the Grand Hyatt Hotel in New York City.

Please hold 8:00 AM to noon on your calendars.

Also make note of our upcoming earnings call dates, scheduled for Thursday October 23 of this year and Thursday, January 29, and Thursday, April 23 of 2015.

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 take a moment to read the forward-looking statement on slide 2.

During today's conference call, we will make certain predictive statements that reflect our current views about 3M's future performance and financial results.

These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties.

Item 1A of our most recent form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions.

Please turn to slide 3, and I will turn the call over to Inge Thulin, 3M's Chairman, President, and Chief Executive Officer.

Thank you, Matt.

Good morning, everyone, and thank you for joining us.

3M performed strong in the second quarter, once again posting organic growth across all business groups and across all geographic areas.

Our team delivered record sales and rising margins, and did so while continuing to build for the future.

Let me take you few through a few highlights for the quarter.

Earnings were $1.91 per share, up 11.7% year over year.

Sales rose to $8.1 billion, which marks the highest quarterly sales in 3M history.

Organic local currency sales growth was 4.8%, led by electronics and energy at 6%.

Healthcare, industrial and safety and graphics each grew 5%, and consumer grew 4%.

Geographic growth was paced by Asia Pacific at 7%.

Europe, Middle East Africa, and the United States, both grew 5%, followed by Latin America/Canada at 3%.

Premium margins remained a hallmark of 3M.

In the second quarter, margins rose to nearly 23%, up 80 basis points from last year.

I'm pleased that all five business groups delivered margins greater than what 20%, demonstrating the breadth of our strength.

As you know, we are managing towards a better optimized capital structure.

This will enable us to invest more in the business and return more cash to shareholders.

During the second quarter, we returned $2 billion to shareholders through dividends and share repurchases.

And as you see on slide 4, last week we announced our plan to acquire the remaining 25% of our Sumitomo subsidiary at the price of $885 million.

This business is a leader in many of our industrial divisions, plus electronics and energy.

In addition, we see significant opportunities in Japan's addressable markets for healthcare, safety and graphics, and consumer businesses.

Upon closing of the deal, 3M will have full control of one of our largest and most successful subsidiaries.

We look forward to growing this business even future in the future.

Now please turn to slide 5. Today, we are reaffirming our earnings and organic growth outlook for the full year.

We continue to expect earnings per share of $7.30 to $7.55, and organic sales growth of plus 3% to plus 6%.

Currency impacts should reduce full-year sales by approximately 1%.

And we still estimate the tax rate of 28% to 29%, with free cash flow conversion at 90% to 100%.

I would like to mentioned a few other notable things from the second quarter.

In April, 3M earned a United States Environment Protection Agency's Energy Star award for the 10th consecutive year.

No other industrial company has been so recognized by the EPA.

Research and development is the heartbeat of our company, and it May, we were pleased to receive our 100,000th patent.

And last month, we appointed Nick Gangestad as our Chief Financial Officer.

I would like to take this opportunity to thank David Meline for contribution over six years, including three years as CFO, which followed three years as Chief Accounting Officer.

Nick now becomes CFO, also after serving three years as Chief Accounting Officer.

Previously, Nick held key leadership positions in multiple business groups around the world, and is well prepared for this, his new role.

He is a 27-year veteran of 3M, and I have personally known and worked with Nick for the last 10 of those years.

He has worked directly with me on executing our financial and operational strategies, and I'm happy to have him as our CFO.

And by that, I give the call over to Nick.

Nick?

Thank you, Inge, and good morning everyone.

Let me just say that I am excited to lead 3M's finance team, and to help the 3M leadership team create even greater value going forward.

And to those of you on the line that I have yet to meet, I certainly look forward to meeting you in the future.

Now please turn to slide 6, and I will take you through our income statement.

The Company operated well in the second quarter, with sales exceeding $8 billion for the first time in our history.

Compared to last year, sales were up 5%, operating income up 9%, and earnings per share up 12%.

Productivity was particularly strong this quarter, which helped fuel more investment in SG&A and R&D, as we continue building for the future.

And at the same time, we expanded operating margins by nearly 1 point.

I will go into a little more detail on the margin change.

Leverage on organic volume added 30 basis points to second-quarter operating margins, and the combination of lower raw material costs and higher selling prices contributed 1.2 percentage points year on year.

Selling prices continue to be supported by technology innovation, which is a key fundamental strength of the Company, and helps drive unique customer solutions and an increasing flow of new products.

We also began raising prices in mid-2013 to help offset currency weakness in select developing countries.

This will result in our price performance moderating in the second half of the year, beginning in Q3.

And on the raw material front, we are benefiting from lower market prices, and from our sourcing team's efforts to reduce costs even further.

Reduced pension and OPEB expense added 50 basis points to second-quarter margins.

Strategic investments this quarter reduced margins year on year by 40 basis points.

This included increases in new, disruptive R&D programs, business transformation and ERP costs, and restructuring.

Foreign exchange impacts, excluding the positive price recovery I just mentioned, reduced margins by 60 basis points.

All in all, second-quarter earnings increased 12% to $1.91 per share.

Foreign currency impacts reduced earnings by $0.04 per share, and a higher tax rate reduced earnings by another $0.05 per share.

Average diluted shares outstanding declined by 5% versus last year's second quarter, which added $0.09 to second-quarter earnings per share.

All things considered, this was a good quarter for the Company.

Slide 7 outlines the details of our second-quarter sales change.

Worldwide organic local currency growth was 4.8%, with volumes up 3.5% and selling prices up 1.3%.

Our businesses have done a good job of executing on their growth plans.

Acquisitions added 10 basis points to sales growth, and foreign exchange had no impact on the second-quarter worldwide sales.

On a total US dollar basis, sales rose 4.9% versus the second quarter of 2013.

As was the case in the first quarter, organic sales growth was positive across all major geographic areas.

Asia Pacific organic growth was 6.6%.

Organic growth was again broad-based, with all five business groups growing, led by our electronics and energy and consumer businesses.

Organic growth was 7% in Japan, or 2% ex-electronics.

China/Hong Kong grew 6% organically in Q2, with -- or 10% excluding electronics, which was an improvement versus the first quarter's underlying growth rate.

Organic growth in EMEA was 4.8% in the second quarter.

West Europe grew 3.5%, Central East Europe grew high single digits, and Middle East Africa grew at a double-digit pace.

EMEA's growth was strongest in safety and graphics, electronics and energy, and industrial.

Our teams in EMEA are executing well in 2014.

In the United States, second-quarter organic local currency growth was 4.5%, up from Q1 and led by healthcare, and safety and graphics.

Finally, Latin America/Canada grew 2.7% organically, with electronics and energy, and healthcare, leading the way.

Mexico generated double digit organic growth, and Brazil was down slightly.

Organic local currency growth was 7% across all developing markets, and 4% in developed markets.

Now let's turn to cash flow.

Turn to slide 8. Looking at first half 2014 results, free cash flow was $2.1 billion, or $143 million above 2013 levels.

Operating cash flow was up $59 million, and capital expenditures were $84 million lower versus the prior year.

We expect the full-year CapEx to be approximately $1.5 billion to $1.6 billion in 2014, down slightly versus a previous expectation of $1.7 billion to $1.8 billion.

We are encouraged to see that our portfolio management efforts are providing greater clarity regarding business unit priorities and their related CapEx needs.

Improved plant productivity is also freeing up capacity, as we continue to improve our plant efficiency and add lean capability over time.

Through the first six months of 2014, we converted 85% of net income to free cash flow, versus 84% in the first half of 2013.

We continue to expect full-year conversion to be in the range of 90% to 100%.

At our 2013 December investor meeting, we articulated plans to manage toward a better optimized capital structure going forward, and to allocate capital accordingly.

The plan calls for additional balance sheet leverage, which we will use for two purposes.

First, to invest in order to expand and improve our businesses, and second, to increase cash returns to shareholders.

We are executing this plan in 2014, evidenced in part by last week's announcement that we will acquire the remaining 25% non-controlling interest in Sumitomo 3M, which Inge covered earlier.

We will finance this deal with non-US cash, and we expect it to close in the third quarter.

We also paid $1.1 billion in cash dividends in the first six months of 2014, up $246 million year on year.

Gross share repurchases were $3.1 billion during that same period.

For full year 2014, we expect gross share repurchases will be in the range of $4.5 billion to $5 billion, versus a previous expectation of $4 billion to $5 billion.

Net debt at the end of June was $2.8 billion, up $1.5 billion versus year end 2013.

During the second quarter, 3M issued $625 million of 5-year debt, at a coupon of 1 5/8%, and $325 million of 30-year debt at a coupon of 3 7/8%.

Next, I will go through the results for each of our business groups, starting with industrial.

Please go to slide 9. Our industrial business continues to perform nicely, with second-quarter sales of $2.8 billion and 5% organic local currency growth.

Our 3M purification business again grew at a double-digit pace in the second quarter, and we also posted nice growth in automotive OEM, aerospace and commercial transportation, abrasive systems, and industrial adhesives and tapes.

On a geographic basis, industrial's organic growth with 7% in Asia Pacific, and 5% in both the US and EMEA.

Latin America/Canada was down slightly in the quarter.

Second-quarter operating income was $617 million, operating margins were 21.9%.

Recall that each of our business groups is absorbing incremental investment in 2014 related to business transformation and ERP implementation.

This had the effect of reducing Q2 margins for each of our five businesses by 30 basis points.

Let's now look at safety and graphics, found on slide 10.

You'll see that safety and graphic sales were $1.5 billion in the quarter, with organic growth of 5%.

Personal safety is a heartland division in 3M, and one of our largest in terms of sales.

It was once again the fastest growing business within safety and graphics, posting high single-digit organic growth in Q2.

We also saw positive growth in commercial solutions, and in traffic, safety, and security systems.

Sales in our roofing granules business declined versus last year's second quarter.

Safety and graphics grew organically in all major geographic areas, led by EMEA at 7% and US at 5%.

Operating income was $353 million in the second quarter, and operating margins were a solid 23.6%.

Please go to slide 11.

Electronics and energy also turned in a good second-quarter performance.

Sales were $1.4 billion, up 6% in organic local currency terms.

Our electronics-related businesses posted organic local currency growth of 11%.

Growth was strong in both display materials and systems, and in electronics materials and solutions.

In our energy-related businesses, sales increased 1% organically.

Second-quarter organic local currency growth was 9% in Latin America/Canada, 8% in Asia Pacific and 6% in EMEA.

The US was flat year on year.

Operating income rose 23% to $293 million, and operating margins were 20.6%.

Next, I will take you through healthcare, found on slide 12.

Building on a strong first quarter performance, our healthcare business once again delivered strong growth and profitability.

Second-quarter sales were just over $1.4 billion, organic local currency sales growth was 5%, and margins were strong at 30.7%.

All businesses contributed to healthcare's growth in the second quarter.

Health information systems, critical and chronic care, and infection prevention led the way.

In April, we also further strengthened our health information systems business by acquiring Treo Solutions, a leader in using data analytics to redesign payment structures and help transition healthcare providers to value-based care models.

Integration efforts are running ahead of expectations.

Healthcare's organic sales grew in all geographic areas, paced by Latin America, Canada and Asia Pacific at 7%, the US at 6% and EMEA at 3%.

Operating income was $434 million.

And again, operating margins were 30.7%.

Adjusting for Treo, operating margins were 31.1%.

I will wrap up with the consumer business group, found on slide 13.

Sales in the consumer business group were $1.1 billion, with organic local currency growth of 4%.

Our construction and home improvement business delivered strong double-digit organic growth in the second quarter, and we also posted positive growth in our consumer healthcare and home care businesses.

Stationery and office supply sales were basically flat year on year.

Second-quarter organic growth across consumer was 4% in the US, which was up from Q1.

Back-to-school activity began in late Q2, so we're off to a good start there.

Elsewhere, consumer's organic growth was 8% in Asia Pacific and 4% in EMEA.

In Latin America/Canada, sales were down slightly in organic local currency terms.

Operating income was $241 million, with operating margins of 21.1%.

That wraps up my review, and now I will turn it back to Inge.

Thank you, Nick.

As you can see, there is a lot to like this quarter across the entire company.

In industrial, for example, our automotive volumes grew 4 times the rate of global auto builds.

And in 3M purification, formerly known as CUNO, organic growth was 13%, and we see this business accelerating in many areas of the world.

I'm encouraged by the growth in consumer after a modest first quarter, which includes a nice improvement in the United States.

Our home improvement division, together with consumer healthcare and home care, all showed good growth.

Our safety and graphic business performed well.

Personal safety, for example, grew 9% globally, including more than 25% in China.

In healthcare, we continue to expand worldwide, with 12% growth in developing markets this quarter.

I'm pleased that all healthcare businesses grew on a global basis.

Finally, in electronics and energy, our portfolio management actions continue to pay off.

Over the past couple of years, we have consolidated several divisions to better align with customers and improve our competitiveness.

Those actions, along with strong volumes, drove margins higher in the second quarter.

Through six months, margins were 19%, and we expect the full year to trend to almost 20%.

Overall, I want to thank our entire 3M team for delivering another strong broad-based performance.

And going forward, we will continue to gain even more value through our three strategic levels: portfolio management, investing in innovation, and business transformation.

Those levels are helping us deliver solid results today, while also building a stronger foundation for long-term success.

Thank you for your attention.

And with that, we now welcome your questions.

(Operator Instructions)

Our first question comes from Scott Davis, Barclays.

Not much to pick on in the quarter.

It was solid overall.

But one thing that wasn't clear in the slides, at least on slide 9, industrials, was margins were down 60 bps.

And you explained 30 bps of it.

But I would thought with organic growth of about 5%, you would've had some operating leverage on that.

So maybe just some clarification on why those margins were down?

Hi, Scott.

This is Inge.

When you think about our business group in industrial, that's the biggest business group for us.

And also the business group that we are historically, and still today, entering first when we go into new markets, based on the size and scale and so forth.

And that is the way we have talked about how we build out businesses from infrastructure, industrial, safety, consumer and healthcare, as their economies evolved.

So if you think about that business on a global scale, the way we operate it, that is like 32% of total company.

When you go to developing economies, it is slightly more.

It is 35%, 36%.

And then you go to emerging markets, which is closer, I would say, to 45%.

So when we looked upon it, and yes, as you said, so why was this happening?

The real reason there is actually, they have a big slowdown in the emerging market in the developing world.

So I'm not concerned at all about it.

In fact, when I looked upon industrial in terms of the growth, which is the important element, we saw a 5% growth in the United States.

We saw 5% in Europe, Middle East Africa, and we saw 11% in China.

So when I looked upon it overall, I am pleased with industrial.

But the reason is the 30 basis point, as you call out.

And then as that portfolio in that type of emerging market, as we all know at the moment, there is some small turbulence, I would say, if you think about Central East Europe.

We have a little bit of impact in Latin America, et cetera.

That's the reason.

But I not concerned, and I don't think you should be concerned either.

We have a very good team that are running those businesses very well.

And you saw automotive, very good.

Purification, again a fantastic quarter.

So all core businesses are doing well there.

Okay.

That helps a lot.

Inge, because you referenced macro.

I think we've had 15 companies report so far this quarter, and I can't tell whether the world is getting better or the world is getting worse.

What is your view on global macro, maybe by region?

Yes.

First of all, there is the macro picture, and then how we will -- how we expect to perform in that world, if you think.

So, first of all, I would say in West Europe, if you think about us, we guided a year from flat to 3%.

And we came out first quarter with 3% -- actually, this quarter more or less the same.

And we still think that that will be the range for us for the year.

So that is a little bit on the positive side for us, in terms of our execution.

In Asia, we saw a slight improvement in China.

Our what I would call base business, and for me, that base business, yes, so we talk the same language is, if I take out electronics, because that is moving around in Asia in between countries.

Our base business in China consecutively went from 8% to 10%, and has a big improvement versus a year ago.

And our Japanese business, in fact, in total, grew 7%.

And if you again look upon the base, that was two.

I would say Asia is going sideways, slightly up, West Europe as we expected, the United States, small strength.

And we had a better second quarter than first.

And as you recall, I said at that time, I am not concerned about the US, because I had a feeling it would come back in the second.

And that was correct.

I think the place where we see a little bit of more of the challenge is Latin America, where we said before for the year 8% to 11%.

And we think now maybe mid-digit for the year.

So slightly down, but it's offset, for us, by other regions of the world.

So I think that's why we're still saying still 3% to 6%.

So I would say that I don't see much of a movement versus what we had talked about earlier.

Latin America slightly slower, West Europe slightly better, US slightly better.

And those are big geographical areas.

So that will compensate more of what you can see, as I will identify as temporarily slowdown in Latin America.

Okay.

That's great.

I will pass it on.

Thanks, and good luck guys.

Thank you.

David Begleiter, Deutsche Bank

Inge, very strong results in electronics and energy.

Can you give us a little more color on the margin expansion you have had in the first half?

And a little bit more margin expansion in the back half to get to the full 20% you're guiding to?

Yes.

First of all, as you recall, we looked upon our portfolio, and it is almost two years ago now.

And we consolidated many businesses that was related to electronic and energy in the Company that in some cases, we had in different components of the Company.

So we talked about streamlined organization, and consolidate in order for us to be faster to market, and be able to respond to the customer need.

We did that, and we combined the division, and the outcome of that is that we get a lower infrastructure to work with.

We have got better utilizational assets, and we are faster to respond to markets.

And we have moved, I would say, from in some cases product sales to more of system sales, which is now paying off.

So I think it's, we had 11% growth in electronics.

And a lot of that is coming to the new approach with this display material system division that is now selling components into solution for the electronic market.

I will say it is a combination of efficiency in the organization, better utilization in manufacturing, and then we had a volume upticks came direct, based on the work we're doing with the customer.

So we think about where we have taken that business for the last 18 months or so, from 15% to 17%.

And actually this quarter, we did over 20%.

But the plan is to go towards 20%, and that's where we are for the year.

I think the plan is 19% plus, and I think that's what we will end up for the remainder of the year.

And so it would be a good year for that group, and they have really responded well to our portfolio management initiatives.

Very good, and impressive.

One more thing, Inge, just in safety.

This double-digit growth you've seen in personal protection, how sustainable is that growth in the back half of the year?

We have a very strong position in that business historically.

It's a fantastic platform for us, and it's very global in scope.

And we are, I would say, the leader in that whole space, relative to respiratory protection.

It is sustainable, and I think the trends are positive for us.

And if you think about some part of the -- you some parts of the world where it's very strong regulations, like United States and West Europe and so forth.

And we're doing well there.

And then you have, I would say, developing economies, and I would put China into developing economies.

So if you see if you think about China, in terms of mega-trends in China, that's -- it's air pollution, it's water, and it's food safety.

When air pollution is playing very well to our very strong position in this business.

So when you see 9% growth for quarter, 25% plus in China, this is sustainable as a business on a global space.

And one of the reasons is, we have scale.

And we have a very professional team in place, and it is a regulatory business, so it is good for us, generally speaking.

A regulated business, sorry.

Thank you very much.

Steve Winoker, Sanford C. Bernstein & Company, Inc.

Inge, just a quick question -- or Nick.

On the Sumitomo impact, you said it is closing September 1. You've got a 12-month $0.08 impact.

You're not changing guidance.

So that first four months, which I would've assumed would be more cost than benefit.

You are just making up for that elsewhere.

How should we think about the dilutive or accretive impact before the end of this year?

Yes, Steve, this is Nick.

You're correct.

We have said that is approximately an $0.08 benefit over the 12 months, and we are expecting this to close on September 1.

At this point, we felt it was premature to up our -- change our guidance at this point.

We're halfway through the year.

Everything is going right down the middle of what we are expecting.

And just as this is a slight upside to our original expectation, we have other things that are on a slight negative.

For example, FX impact.

We started the year thinking that would be flat to hurting us by $0.05.

We are now in the $0.07, $0.08 range of impact.

All in all, we think everything is staying very close to our original guidance.

Steve, this is Matt.

Maybe one follow-up.

The transaction should not have a lot of costs associated with it, from an integration standpoint.

But third quarter, we expect really de minimus impact on earnings.

And assuming we close on September 1 as expected, we would expect some slight accretion, and you could think about it on a straight-line basis using that $0.08 as a guide.

Fantastic.

That's very helpful.

The other point is on CapEx.

That, roughly, what, $200 million lower guide than last quarter.

And you called out some of the lean and other impacts that you're having.

But this is a -- strikes me as a really potentially massive shift in terms of what you're getting out of this.

Can you maybe talk, also, are there any things that you're deferring what you aren't doing?

Even year on year, it is lower now.

And should we rethink our business model on the CapEx side for 3M going forward, based on what you're getting as indicated here?

Or am I making too big a deal out of it?

Steve, I appreciate the question.

Our business model, over a longer period of time is we invest between 4.5% and 5% of revenue in CapEx, and we started the year with an estimate on the high end of that range.

As we've gone through the year, and we're seeing those benefits which I talked about earlier, we're seeing an opportunity that we don't need some of the capital that we started out the year anticipating we may need.

There is really, I would say, Steve, to your question, should we change the modeling going forward?

No.

We're basically in that 4.5% to 5% range, and we expect to stay there as a temporary, what we're seeing of the benefits this year, and really reflects great results that the team is doing so far this year.

We are not holding -- we don't hold back on any investment relative to our growth.

So that will -- we continue them as we have laid out.

But again, for me, it is a positive sign relative to the operation here, in terms of, in some cases, better utilization around the world, right?

And if you think about our strategy, it is the fourth strategy that, as we laid out, where we type of -- talk about intensified capabilities to [sheer] regional self-sufficiency.

I think we have been able to start to move in that direction.

But it is too early to change the model by definition.

But I think as this year, this is what it look for us.

And then we think is the right time now.

We have to correct that for the year.

Okay.

Thanks.

I will pass it on.

Andrew Obin, BofA Merrill Lynch.

I just wanted to follow up on Steve's question.

Just thinking about energy and electronics, I know this was a big focus for the team in terms of improving efficiency of this business.

You guys have alluded sourcing initiatives.

You have alluded planned productivity initiatives.

Do you care to quantify the impact of those?

And when, if not now, when do you think we will hear about more discreet items there?

Andrew, in terms of productivity, we have --in the past, we have shared in our margin walk how we see productivity impacting -- or positively or negatively our results.

If you think back to a year ago, we were showing with utilization, a negative impact on our financial results.

This quarter, we are not showing that.

Year on year, we're seeing a benefits by that lack of headwind.

And in measuring productivity in our plants, something that was slightly negative in 2013 has turned slightly positive for us in the first half of this year.

Okay.

But it just seems it is a broader initiative than it's just quarter over quarter change, but I guess we can take that offline.

The other question, though, on the CapEx question.

You did cut CapEx, yet you left your cash realization target intact.

So is there extra cash consumption on the working capital side?

Or are you just being conservative right now?

I think we also would like to keep the flexibility as we go here.

The way I think about it, and we think about it, we are like six months into the year, and we would like to keep the flexibility as we go.

There is two more quarters, and we will able hopefully to talk more about it on the next quarter, as we move ahead.

Terrific.

Thank you very much.

Thank you.

Nigel Coe, Morgan Stanley

Nick, you mentioned the expectation of pricing would start to lap over comps.

What about the other side of the equation, raw materials?

It looks like raw materials are pretty flat year over year in Q2.

I'm just wondering what you're seeing in terms of trends in some of your key raw materials?

Nigel, on the raw material front, we have been seeing our raw material prices in aggregate drop between 1.5% and 2%.

We saw that in the first two quarters of the year.

We expect that to continue.

And it's, if you think back to the guidance we gave at the beginning of the year, we expected raw materials to benefit us by $0.05 to $0.15 for the year.

We still see ourselves in that range probably tracking closer to the high in that range.

Okay, so raw materials are still down year over year in the second half of the year.

Yes, Nigel.

Yes.

Okay.

And then secondly, on the ERP.

Just wondering if you could talk about where you are versus plan on the rollout this year?

And I noticed that the early stages resulted in lower corporate, as you were allocating costs more to the segments.

And I noticed that corporate was a little bit lower year over year.

And I'm wondering, did the -- is the ERP continuing to have that impact between corporate and segment?

Yes.

We don't plan relative to the rollout.

We have -- we talked about earlier, rolled out now in five countries around the world.

We have, in addition to that, rolled out four distribution centers in West Europe or Central East Europe, so we have done one in the UK.

We have done one in France.

We have done one in Poland.

And just the beginning of this month, we roll out the biggest one, which is in Juchen in Germany, our biggest distribution center in West Europe.

And I was, in fact, myself over there just the week before.

And then followed up slightly after that and walked the floors, relative to make sure we are the team that we were prepared for that cut-over.

And I am very pleased to say it's going very well relative to that execution.

So I would say that, even as you know, when you make those moves, right, you always learn a little bit on every place, and we have.

And I would say we just take those learnings, and we step up our mitigations and the team in place, in order to be more effective as we implement as we go ahead.

In terms of the financials you see there in terms of cost, it's still accurate.

There's no change to that.

And we say that, as we move ahead, probably we would like to make sure we maybe can accelerate some of the implementation in places where we can get even better financial benefits.

So maybe not change the figure in terms of end goal, but see if we can capture something earlier and get more focus around it.

But so far, so good.

But again, as you know, there's always a little bit of changed management, as you do those type of things.

But I think the important thing, the prime metric for us, is customer satisfaction.

Right.

And Nigel, to add -- this is Nick.

I want to add one point on that.

The 30 basis point increase in spending that we're seeing in our five businesses are from spending that we are now putting into the businesses to do this.

And this is not a shift between corporate miscellaneous and the businesses.

If you're looking at the corporate miscellaneous piece, the year-on-year change there is really driven by a reduction in our pension expense, largely as we had laid out at the beginning of the year.

Okay.

That's very helpful.

Thanks very much.

Thank you.

Deane Dray, Citi Research.

I was hoping to get some more color regarding the growth investments.

You said it was a 40 basis point hit that's broadly across 3M.

But how did that impact the individual segments?

And what kind of return are you expecting on both the pure new products, but as well as the restructurings?

Dean, our growth and our strategic investments come in -- there's multiple categories there.

One is our invest in innovation, as you're alluding to.

And that is still in an investment mode, where we're working to develop those new technologies for the future.

And we're not expecting an accretive benefit to growth from those investments in 2014, and little in 2015.

For the rest of our strategic investments that we've talked about, part of that is restructuring.

And part of that is our incremental investment in business transformation and ERP.

Those are tracking approximately where we have expected.

On the restructuring front, we are about halfway through the year, and we have spent about half of what we expect to spend for the year on restructuring.

Benefits, in the last half of the year, we still see in low single digit millions of dollars.

We expect more benefit from that, into the teens of millions of dollars, in 2015.

Great.

Thank you.

And for Inge, it was interesting, at the very end of your prepared remarks, you cited some upside in the business, the CUNO filtration business.

There was a big multiple paid in that business a while ago, but it looks like it's beginning to deliver the way you all had envisioned it.

So what is that longer opportunity for CUNO in the portfolio?

And you have hinted in the past you might be interested in doing some more water investments.

And how do you see that opportunity?

Yes.

I think, first of all, that what we now call purification is business that, during the last couple of years, really improved for us.

So let's really put out a little bit of perspective.

You talked about when we purchased that that the multiple was high and so forth, right?

I think initially, when that was purchased, we didn't integrate it fast enough into 3M.

So if you think about what we are looking for as fundamental growth drivers for any business, it is around technology, manufacturing, global capabilities and brands.

Those are the things that we need to capture when we purchase something.

I think in that case, we hold -- and that's now many years ago.

But I think we hold it aside too long before we really start to drive the value that 3M will add in those four categories.

The last three years that have now taken place, and they have done a fantastic job, in my mind, relative to efficiency and operational excellence, consolidation of manufacturing, start to lay in some of the technologies that can help them.

And then start to use the global capabilities in terms of our footprint.

That's why you now see, quarter on quarter, sequential good growth.

It was 13% this quarter, was very similar first quarter of this year.

And in many market, we see huge opportunities as we go ahead, based on our current portfolio.

So it is difficult to give you a figure, as you look upon it.

But again, I go back and say that it is clear that clean water and clean air is a very important element in most parts of the world.

And specifically, I would say in developing world.

And that's also where we see a fantastic growth rate for this business.

So I -- this is a very good space for us, and I'm very pleased where we stand today with that business.

And we will continue to invest as we go ahead, for more growth and also efficiency in the organization.

Thank you.

Laurence Alexander, Jefferies.

I have two quick questions.

Your China and -- or your greater China business, what's the -- how fast is that growing now?

And in the comments about the energy-related businesses growing only about 1%, and telecom being the leading part of that, can you talk about how weak the rest of that business was?

And were there any other end markets that decelerated in the quarter?

Let's start with what we call China/Hong Kong, in terms of that operation.

We had -- in this quarter, we moved from Q1 8% growth to 10% growth in the quarter for China.

So -- and if you compare that on that base business, that was only 1% Q2 last year.

Year over year, good improvement, and over last quarter, also slight improvement.

That is moving forward positively.

And again, you see in businesses there that you take industrial, was 13% growth in the quarter, healthcare was 17%, consumer and office 20%, and you have safety and graphics just over 10%.

So it is moving ahead very well.

And I think we are past the time where China was at 25% for the quarter, but we are running that now at 10%, and with slight uptick.

So that's good, and we feel good about where we stand today in China.

Relative to the energy piece, there is some tender business going on in that business, and that can hit us a little bit.

So you saw telecom had 4% growth, and then some of the other businesses was down.

But was not much big figures on the downside.

And I some -- I would say tenders that is going, because some of it is government-related and utility-related, so it can move a little bit in between quarters.

But nothing to be really concerned about, and we have -- one of our heartland divisions is part of that.

So it was not much down.

Just a little bit.

We're very pleased that telecom grew 4%.

That was a good figure for us.

Thank you.

Jeff Sprague, Vertical Research Partners

I was wondering if we could just go back to the cash flow discussion a little bit.

A good discussion so far.

I just wanted to talk about working capital a little bit.

Nick or Inge, as I think about the ERP and the distribution centers and the like, is there a release of working capital that we should be expecting?

If it's not this year, into next year?

So you've got really very little operating cash flow growth year to date.

So I don't know if that is tied to these distribution centers, or if you could just comment on how that plays out going forward?

Yes, Jeff, on the cash flow and the working capital, managing our inventory continues to be one of our important priorities, and improving our inventory turns.

Making some progress there.

We expect more progress on that in the coming quarters.

Specifically to your question about business transformation, ERP and the impact that could be having.

Over the long-term we are convinced that where we're going with business transformation and ERP that we have significant opportunities to improve our working capital, in particular, inventory management, and generate benefits there.

In the short-term, in particular in the second quarter, with some of our go-live activity we had, there was minimal.

I will call it in that $10 million to $30 million increased inventory in some of the channel in anticipation of go-live activity.

But Jeff, your question was the longer-term, and it was a little hard to tell on our end.

We have talked about a longer-term opportunity in working capital, but it's -- that bigger win is not something we would expect in the next year or two, necessarily.

We have sized that at about $500 million.

Okay, thank you for the clarification there.

And then I'm just wondering on, share repurchase, is there -- we obviously can do the math on the share price and figure out what a dollar buys these days.

But is there any additional pressure on just other dilutive effects, option exercises, or anything else that eats against the gross number?

No, there's nothing out of the ordinary there, Jeff, that's happening on a dilution basis.

We did pick up our activity some in the first half of the year.

We saw it as a good opportunity.

And on the dilution front, very similar to trends to what we've seen in the last year.

Great.

Thank you.

Our next question comes from Ajay Kejriwal, FBR Capital Markets.

Maybe on energy, so the work you are doing on consolidating the divisions, showing in the margins here.

The question is, is this improvement, is this a couple quarter phenomenon?

Or do you think this could be -- there could be runway for a couple of years here?

And the business has been below company margins.

So do you think there's opportunity to take margins up to more near the Company average levels?

Think about it in this way.

We are running around 22% to 23% margin as an enterprise.

We have some businesses that is running in the middle of that, and you have two that is type of -- one is higher, which is healthcare.

And then you have electronic and energy that is lower.

And as you recall, when we started the journey, this was around 15 plus.

That industry, by definition, that's a good margin in that industry by definition.

And that will always be a differentiation.

So I will say that this move from 15 closer 20 over this period of time was our expectation.

If it will go more up in the area of 25 to 30, I do not think that's realistic for that market in order for us to do that.

But I think any business in 3M, we -- our expectation is that you should be close to the average of the Company.

So -- and our organization there today is more streamlined, and I think we are better prepared, also, to deal with some eventual volatility in that market, on the electronic side, that we know will come from time to time.

That's part of that business, and we are playing that business, so that's okay.

Good.

That's helpful.

And then Treo, could you maybe provide some color on the margin profile there?

And then, how should we think about the trajectory and the impact on segment margins, as you integrate that business?

Yes.

First of all, that is an integration into our healthcare -- health information system.

So that business had been growing.

Health information systems had been growing very well for us the last 5 to 10 years.

And you should think about it in terms of that this acquisition is actually an addition in order for us to get more relevance into different parts of the segment.

So health information system today is a growing business, and we are doing that for providers in coding, grouping and analytics, and that is through hospital providers.

Now, we will get access to a vast set of payers that then they can help to connect the two of them.

It's -- the model is moving from volume based to quality outcome, this is what will help.

I will look upon it as an integrated part of the current business we have.

And it is a relatively small business, as you know, so it is more for us to be able to get access and connect the two entities together.

Joe Ritchie, Goldman Sachs

My first question is on price cost.

Clearly another good quarter, above 100 basis points.

But it looks like LatAm FX was a benefit.

Can you just quantify the tailwind that you got in the quarter from FX on the price cost piece?

Yes, Joe, thanks for that question.

For the quarter, on the topline, we really saw no impact from FX.

Everything netted out to nothing.

What we're seeing as a negative impact on our margin this year, year on year, is the fact that we had significant hedging gains a year ago as part of our strategy.

And the lack of those gains is causing that margin year-on-year margin erosion.

Really has nothing to do with 2014; it has to do with the gain we took last year on our hedging.

Yes, Joe, is part of your question how much price we may have gotten due to currency?

Yes.

That's right, Matt.

Yes.

Yes, as we've said last quarter, about half of our price we really see as currency-related, and we think that will be running its course soon.

We instituted a lot of price increases related to currency in the middle of last year, and so that's the primary driver, why we're saying we expect that prive growth to moderate in the last half of 2014.

Okay.

That's helpful, Nick.

And one follow-up, maybe for Inge.

Inge, you mentioned that you brought down your growth expectations for LatAm.

It looks like you had negative volume growth in the quarter.

And so maybe if you could just provide some positives and maybe areas of weaknesses that you're seeing in a region today.

Latin America, first of all, we have probably the best portfolio mix in that part of the world.

So we feel very good relative to our overall platform, as we move ahead.

And as you know, we have been doing business in Latin America since, I think 1946, was when we started in Brazil.

When you look upon it now, there was a little bit of temper, specifically in Brazil, especially in Brazil, I would say.

Brazil was flat to down.

Mexico was up 12.

So I would say Brazil had an impact for different reasons.

And then for us, at least, what we are selling, personal safety into the mining, was also on the lower end.

So I think that Brazil was, for us, the downturn this quarter, specifically, and then Canada was flat.

You have Latin America/Canada together.

Canada flat, Brazil down.

Most other up, and Mexico up 12.

But as I said, this is a part of the world that is the most developed of our developing regions, and we know how to do business there.

So (inaudible), for me, always, when I look upon Latin America over the years, and I follow that, as you know, I led international for eight years before I came into this job.

We have a constant growth over time in Latin America, but that could be a little bit a bp in the quarter.

But that is not at all an overall concern for us.

We are just short term, stay the course and capitalize on the future.

Thank you for taking my question.

Thank you.

Thanks, Joe.

Stephen Tusa, JPMorgan.

Just on the price cost thing, on the deflation on your raw materials.

How much of that -- I guess you said 100 to 150 basis points for the first half.

How much was it precisely in the second quarter?

And then how much of that do think is blocking and tackling, and kind of structural?

Like every year you can bang out a certain amount of that?

It seems to be kind of a nice tailwind for a while now.

I appreciate that question, because it gives me a chance to make it clear here that the benefits we see on raw materials are not just a passive benefit that 3M gets by being in the market.

There are some benefits we get thanks to the market.

But a lot of this, Steve, it is driven by what our sourcing team is doing in 3M to bring about those benefits.

So of that total 1.2%, 1.3% benefit that we're seeing in the second quarter, there is a portion of that that is raw materials.

Probably a little less than half of that that is raw material-driven.

And that raw material portion is made up of several components.

One is just outright market conditions where we're enjoying that benefit.

Second is what we're doing from a 3M perspective to drive those benefits and use our power in the market to benefit there.

And then the third is, there is a portion of that that involves us substituting one raw material for another to 3M's advantage.

So it is a broad perspective of what's driving that number, Steve.

So out of the 1.2% to 1.3%, how much is just -- maybe just to narrow it down, how much is just market exposure-related?

Half -- like 25% of that or --

I think it is around half, Steve.

Because we looked at the raw material deflation this quarter.

Yes, you could think of it -- and it varies a little bit from period to period, but it's about half market and half due to the additional value we can add.

That's very helpful.

Then one just quick follow-up on electronics.

These cycles has been notoriously tough to predict.

And I'm not sure if there is a good way to forecast this, but how do you feel about the growth there in the second half?

Sequentially, it was definitely stronger than we were expecting it, up high single digits.

Should we think about normal seasonality in the back half of the year?

And what is your sense of inventories of customers at this stage of the game?

Yes.

You start on the inventory side, we don't see any buildup in the channels.

So I think that's -- it is at a normal level as in the past.

So if we start there, based on your last point of your question.

Otherwise, I would say it looked like you can think about it in normal way of the season.

But also, for us, we work with all suppliers in that industry, and it will all be dependent on the end of market demand in the end.

So for us, that will be the growth driver -- more or less growth driver, as we move ahead.

But I don't think there's any change for us at this point in time, relative to the outlook for the growth of electronics and energy in that business.

(multiple speakers) One last quick one.

Just on the -- you have an easier comp in the third quarter, tougher comp on the fourth quarter on gross.

Or I think it may be the other way around.

But anything in the comps that move around, as far as stability of growth rates in the second half?

Are you talking electronics or total company, Steve?

No, just total 3M organic.

It looks like the midpoint averages around 4% growth.

That may be conservative or not.

But should one quarter be better than the other, because of the comparisons?

No.

I think you can -- think about it in the following way.

If you go back to 2013, first half, we had 2% organic local currency growth.

Second part, we have 4%.

First part of this year, we are close to 5%.

And I think you should think about this as we move ahead for the year, that based on the range we're giving, is 3% to 6%.

So I think it would be very much in that range for the last quarter.

Simple.

Thanks.

Appreciate it.

Thanks, Steve.

That concludes the question-and-answer portion of our conference call.

I will now turn the call back over to 3M for some closing comments.

I would like to thank everybody for joining us today.

We appreciate your engagement and interest in 3M.

We look forward to talking to you soon.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation, and ask that you please disconnect your line.