3M (MMM) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the 3M second-quarter earnings conference call.

(Operator Instructions)

As a reminder this conference is being recorded Thursday, July 23, 2015.

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

Thank you and good morning, everyone.

Welcome to our second-quarter 2015 business review.

On the call today are Inge Thulin, 3M's Chairman, President and CEO; and Nick Gangestad, our Chief Financial Officer.

Each will make some formal comments and then we will take your questions.

As a reminder, please mark your calendars for upcoming earnings call dates; October 22 and January 26.

Also take note of our next investor meeting scheduled for December 15.

More details will be available as we get closer to that date.

Today's earnings release and the slide presentation accompanying this call are posted on our investor relations website at 3M.com.

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 hand off to Inge.

Thank you, Matt, and good morning, everyone, and thank you for joining us today.

Overall this was a good quarter for 3M, marked by broad-based organic growth and margin expansion.

We continue to operate in an uncertain global economic environment which softened growth.

At the same time, we grew organically in all geographic areas, expanded margins a full percentage point and increased net income.

Most importantly, we maintained our commitment to managing 3M for the long term with strong investments in our portfolio.

Let's go through a few of the second quarter's numbers.

Earnings per share rose to $2.02, a 5.8% increase year-over-year.

Our team posted local currency sales growth of 2% Company-wide.

On an ex-electronic basis growth was 2.2%, the same as Q1, and I will talk more about our electronics business shortly.

Organic growth was positive in all geographic areas, paced by the United States at 4%.

Four of our five business groups grew organically, led by safety and graphics at 5%, followed by consumer and health care businesses at 3%.

Growth in industrial slowed a bit to 1% as we experienced channel inventory adjustments in general in the industrial markets.

Electronics and energy declined 3% organically in the quarter.

This business group faced a tough year-on-year comparison and we also saw somewhat softer consumer demand in the electronics markets.

However, even in softer market conditions we increased margins in electronics and energy to more than 21% for the second straight quarter.

As you recall, last year we consolidated a number of businesses within electronics and energy to better align to customers and generate efficiencies, and that portfolio work is paying off.

I am pleased with the progress of this business, and going forward the team is focused on driving spec-in wins, increasing productivity and advancing our technology's capabilities.

In the second quarter we saw continued strength of the US dollar, which reduced Company-wide sales by 7.3%.

As a result, total sales declined 5.5% to $7.7 billion.

We increased 3M's operating margins to 23.9%, up 1.1 percentage points.

This marks the seventh consecutive quarter of year-on-year margin expansion Company-wide.

Our margins remain strong and broad-based as all business groups posted margins greater than 21%.

This is a testament to the strength of our portfolio and business model, and our business teams around the world driving productivity each and every day.

In the second quarter we also continued to actively deploy capital in order to improve the business and return cash to shareholders.

We returned $2.3 billion to shareholders through dividends and share repurchases.

And just last month we announced the acquisition of Capital Safety.

Capital Safety is a leading global provider of fall protection equipment and will bolster 3M's personal safety business, which is a strategic priority in our portfolio.

This acquisition builds upon a number of other portfolio actions we have taken to strengthen our portfolio.

Please turn to slide number 4. Portfolio management is one of our three strategic levels and is vital to our success.

To succeed in the long term we must constantly evolve to meet the changing demand of our customers and the global economy.

Back in 2012 we began a comprehensive review of 3M's portfolio and started to make changes to better align our portfolio to our long-term strategic objectives.

This includes reallocation of resources to our best opportunities.

It also means taking actions to create a greater value, such as combining businesses within our Company to increase customer relevance, scale and productivity, acquiring businesses that align with 3M's fundamental strength and strategic objectives, and divesting businesses that no longer align with those strengths or objectives.

In the first half of 2015 we took action on all fronts.

Earlier this month for example, we combined two of our health care businesses.

Our dental and orthodontic business, which are both recognized for their strong technology and brands, were merged to form a single Oral Care Solutions business.

Now, through a seamless and single partnership, we can offer customers an entire suite of oral care innovations, thus increasing our relevance and generating efficiency.

In fact since 2012, we have consolidated businesses with each of our business groups.

As a result, we have moved from six business groups to five and from 40 businesses to 26.

Next, our acquisitions.

Earlier I talked about last month's announcement of Capital Safety.

In February we also announced a $1 billion acquisition of Polypore's separations media business, which will enhance 3M's core filtration platform.

And in March we acquired the Ivera Medical, a strategic addition to our health care business group.

At the same time in January, we sold our static control business after thorough strategic review.

Because of our team's work 3M is now leaner, more focused and better positioned to win big opportunities and create greater value for customers and ultimately for our shareholders today, and even more so in the future.

Thank you and now I will turn the call over to Nick for more details on the quarter.

Nick?

Thank you, Inge, and good morning, everyone.

Let's begin on slide 5 were I will describe the elements of second-quarter sales growth.

We generated organic local currency growth of 1.8%, with volumes contributing 0.8% to our growth and selling prices adding 1%.

The sales impact from acquisitions, net of divestitures, was neutral in the quarter.

Positive growth related to the Ivera Medical acquisition was offset by our divestiture of the static control business.

Foreign-exchange impacts reduced sales by 7.3 percentage points in the second quarter.

The most notable currencies impacting sales were the euro, yen and Brazilian real, which devalued versus the US dollar by 20%, 17%, and 28%, respectively.

In dollar terms, worldwide sales declined 5.5% versus second quarter of 2014.

On a geographic basis, the United States led the way with organic local currency growth of 4.1%.

US growth was broad based, led by safety and graphics and consumer at 6%, health care at 4% and industrial at 3%.

Latin America/Canada posted organic growth of 0.8% in the quarter.

Growth was positive in our health care and industrial businesses, while safety and graphics and electronics and energy both declined organically.

Mexico delivered another outstanding result with 17% organic growth in the quarter, and Brazil turned positive with 1% growth.

The impact of year-on-year sales declines in Venezuela reduced organic growth in Latin America/Canada by 4 percentage points in the quarter.

This headwind is behind us starting in Q3.

Organic local currency growth in Asia Pacific was 0.5% in the quarter, with health care and safety and graphics each growing 9% and consumer growing 3%.

Electronics and energy declined 4% organically in Asia Pacific.

Organic growth was down 2% in China/Hong Kong in the second quarter.

Health care delivered strong growth which was offset by declines in safety and graphics, electronics and energy, and consumer.

We continue to see the Chinese economy adjusting to new growth levels and we saw channel adjustments in some key end markets, which impacted our growth.

For the full year 2015 we now expect organic growth in China/Hong Kong to be in the mid single-digit range versus mid to high single-digits previously.

Japan delivered another good quarter with second-quarter organic growth of 2%, or up 7% excluding electronics.

health care and safety and graphics posted strong organic growth followed by steady growth in our consumer and industrial businesses.

Turning to EMEA, organic growth was 0.4% in Q2, with West Europe declining 1%.

Organic growth in Central East Europe increased high single-digits while Middle East/Africa was down mid single-digits.

Organic growth in EMEA was led by safety and graphics at 4%.

Health care was flat and industrial, consumer and electronics and energy each declined 1%.

Please turn to slide 6 for the second-quarter P&L highlights.

Second-quarter sales were $7.7 billion.

Operating margins improved by 1.1 percentage points year-on-year to 23.9%.

Strong gross margin improvements, along with productivity, drove the second-quarter operating margin performance.

Let me cover the primary components of the change in margin.

On the positive side, the combination of lower raw material costs and higher selling prices contributed 150 basis points of margin expansion.

Pricing performance in the second quarter remained steady, driven by continued new product flow across our businesses and price increases in select countries, to help mitigate the impact of currency devaluations.

We continue to benefit from lower raw material costs and expect this trend to continue throughout the year.

Commodity prices remain favorable and our global sourcing teams continue to generate additional cost reductions.

Productivity remains strong in the second quarter, adding 50 basis points to margins, driven by Lean Six Sigma efforts, returns on past portfolio actions and continuing to prioritize investments.

Strategic investments reduced margins by 30 basis points.

This includes our ERP and business transformation effort, increased R&D investments aimed at disruptive innovation, along with portfolio management actions.

These investments will strengthen 3M for the future.

Finally, higher pension and OPEB expense reduced second-quarter operating margins by 60 basis points.

As a reminder, this year's pension expense increase is due to the adoption of new mortality tables along with a lower discount rate.

For the full year we continue to expect operating margins to increase by approximately 1 percentage point.

Let's now turn to slide 7 for a closer look at earnings per share.

Earnings per share for the second quarter was $2.02, a year-on-year increase of 5.8%.

Organic growth and margin expansion contributed $0.12 to the EPS increase in the quarter.

This result includes a negative $0.05 impact from higher year-on-year and OPEB expense.

Foreign currency impacts net of hedging reduced pretax earnings by $110 million, or the equivalent of $0.12 a share.

The second-quarter tax rate was 28.1% versus 29.5% in last year's comparable quarter, which increased earnings by $0.04 per share.

The reduction in the tax rate versus last year's Q2 was driven by adjustments to tax reserves, which were partially offset by geographic profit mix.

Reserve adjustments were anticipated in our tax rate guidance.

Finally, average diluted shares outstanding declined by 3% versus last year's second quarter, which added $0.07 to second-quarter earnings per share.

Let's now review cash flow.

Please turn to slide number 8. Second-quarter operating cash flow was $1.3 billion, down $300 million year-on-year.

The majority of the year-on-year decline was due to higher cash taxes.

We invested $370 million in capital expenditures during the second quarter, up $29 million year on year.

For the full year we continue to expect capital expenditures in the range of $1.4 billion to $1.6 billion.

Second-quarter free cash flow was $1 billion and we converted 74% of net income to cash.

For the full year we continue to expect free cash flow conversion in the range of 90% to 100%.

Cash dividends paid were $646 million in the second quarter, up $90 million year-on-year.

As a reminder, we increased the per share dividend by 20% this past February, which marks the 57th consecutive year of dividend increases.

Gross share repurchases were $1.7 billion in the second quarter, up $269 million compared to Q2 2014.

Through the first half of 2015 we have repurchased $2.6 billion of our own shares.

We now expect full-year gross share repurchases to be in the range of $4 billion to $5 billion versus a prior expectation of $3 billion to $5 billion.

Let's now review our second-quarter performance on a business-by-business basis, starting with our industrial business.

Please turn to slide number 9.

Industrial posted sales of $2.6 billion in the quarter with organic local currency growth of 1.4%.

Industrial's organic growth was led by 3M purification and aerospace and commercial transportation, each generating double-digit growth in the quarter.

The automotive OEM business posted mid single-digit growth in the quarter versus a slight year-on-year decline in global car and light truck builds.

We continue to improve our market share in this large and important market.

We also delivered positive organic growth in automotive after-market in Q2, while the industrial adhesives and tape business was flat.

On a geographic basis, the US and Latin America/Canada set the pace, with each posting organic growth of 3%.

Asia-Pacific was flat, while EMEA declined 1%.

The industrial business delivered operating income of $609 million in the second quarter.

Operating margins were a strong 23.1%, up 120 basis points year over year, boosted by positive price raw materials.

Let's now turn to safety and graphics on slide 10.

Second-quarter sales in safety and graphics were $1.4 billion, increasing 4.9% organically.

All businesses within the portfolio grew organically, led by the roofing granules business which posted strong double-digit growth in the quarter.

Personal safety, one of 3M's heartland businesses, grew mid single-digits in the quarter.

This business is a strategic priority for 3M for several reasons, including our strong product portfolio, fast-growing end markets and increasing regulatory standards across developed and developing markets.

As Inge mentioned, the Capital Safety acquisition will strengthen this business even further.

Geographically, organic sales growth in safety and graphics was 9% in Asia Pacific, 6% in the US and 4% in EMEA.

Latin America/Canada declined 2%.

Operating income was $364 million and operating margins increased 1.8 percentage points to 25.4%.

Margin improvements were driven by price raw material benefits, along with productivity and portfolio management actions.

Let's now turn to health care.

Please turn to slide 11.

Health care delivered sales of $1.4 billion in the second quarter with organic growth of 3.4%.

We continue to see broad-based organic growth across much of the health care portfolio, including food safety, health information systems, oral care, critical and chronic care and infection prevention.

Drug delivery systems, which is the project-based business, declined year on year.

The Ivera Medical acquisition added 70 basis points to health care sales growth in the quarter.

Geographically, organic growth in health care was led by Asia Pacific at 9% with strong contributions from both Japan and China/Hong Kong.

Latin America/Canada grew 5%.

The US was up 4% and EMEA was flat.

Health care's operating income was $440 million and margins rose 160 basis points to 32.3%.

Primary drivers of margin expansion included strong productivity and a price raw material benefits.

Next we will look at electronics and energy on slide 12.

In electronics and energy sales were $1.3 billion for the quarter, down 3% in organic local currency.

Operating margins increased 60 basis points to 21.2%, and operating income was $277 million in the quarter.

Our portfolio management actions in this business continue to yield benefits for our customers and improve productivity, which is leading to strong operating margin performance.

Organic local currency sales declined 2% on the electronic side of the business.

As Inge commented, we experienced softer conditions in the electronics market for the quarter.

The business remains focused on continuing to drive successful spec-in wins with electronic OEMs.

In our energy related businesses organic local currency sales were down 3%, consistent with first-quarter growth patterns.

On a geographic basis, organic sales growth in electronics and energy increased 1% in the US.

EMEA declined 1%, Asia Pacific was down at 4% and Latin America/Canada declined 7%.

The divestiture of the static control business reduced sales by 70 basis points in the second quarter.

Please turn to slide 13.

Second-quarter sales in consumer were $1.1 billion with organic growth of 3.4%.

We grew organically across the portfolio with particular strength in the do-it-yourself business, led by strong growth of Scotch blue painters tape.

Our stationery and office supply, home care and consumer health care businesses also delivered positive organic growth in the quarter.

Second-quarter is typically when we begin to see the impact of the back-to-school season.

Growth has been encouraging to this point, most notably in our line of Scotch brand home and office tapes and command solutions, which eliminate the need to pound nails into walls when hanging pictures, decorations or other items.

Looking at the consumer business geographically, organic growth was led by the US at 6% and Asia Pacific at 3%.

Latin America/Canada was flat and EMEA declined 1%.

Operating income increased to $259 million and margins were 23.3%, up 2.2 percentage points year over year.

Margins were boosted by lower raw material costs, portfolio prioritization, strong productivity and timing of promotional programs.

That wraps up our review of the second-quarter business results.

I will turn it back over to Inge for an update on our 2015 planning estimates.

Thank you, Nick.

Overall, 3M delivered a good second-quarter performance.

Organic growth remained broad-based and we continued to generate premium margins across the portfolio.

Looking across 3M's entire team, I'm very pleased with our execution and discipline in an uncertain economical environment, which is evident in our strong productivity.

Going forward, we expect that economic uncertainty remains through the year.

In fact, external growth forecasts have continued to moderate over the last several months.

As a result, today we are updating our guidance for the full year.

We now expect organic growth of 2.5% to 4% versus the prior expectation of 3% to 6%.

With respect to earnings we now anticipate EPS in the range of $7.80 to $8 versus the prior range of $7.80 to $8.10.

The rest of the guidance remains in place.

As you can see, we still expect currency to reduce sales by 6% to 7%.

Our tax rate guidance is unchanged to 28.5% to 29.5%.

And we continue to expect the free cash flow conversion rate of 90% to 100%.

Like always, our 3M teams are focused on executing our plan, making investments for the future and managing those things within our control.

In other words, controlling the controllable.

As I described earlier, our portfolio is strong and getting stronger as a result of our recent investments.

Going forward, each of our businesses will continue to be bolstered by 3M's four fundamental strengths: technology, manufacturing, global capabilities and our brand.

Those strengths are leveraged across our Company and will allow us to gain market share, maintain world-class margins and generate efficient growth in the future.

Thank you for your attention and we will now take your questions.

(Operator instructions)

Joe Ritchie, Goldman Sachs.

Thank you and good morning, everyone.

Inge, touching on organic growth for a second, you're tracking towards the lower end of the full-year guide so far year to date, and there still seems to be a lot of uncertainty in the environment.

I'm wondering, how are you thinking about your base case for the rest of the year given what you are seeing geographically and across your product portfolio?

As you recall, we saw -- all of us saw -- a slow economic environment coming early in the year.

After the first quarter we thought it was too early for us to change the guidance for the year.

I think it now as we moved in and saw the second quarter coming through here, I think it is the right thing to make sure that we adjust that guidance.

Now you can see basically the Industrial Production Index came down even a couple of weeks ago from 2.6 to 2.1.

Based on that and based on our portfolio, we think it is prudent for us to take it now to 2.5% to 4%.

This is what we had earlier.

I would say, if I just comment on the organic growth for the quarter, the thing that changed for us in the quarter was basically the electronics.

Electronics was two things.

One was a tougher comparison versus last year.

We had 10% organic local currency growth a year ago, and then it became some softness in that segment.

When I look upon it, the second quarter is very similar to the first quarter in terms of growth, excluding that piece.

I think that the 2.5% to 4%, I think that is a reasonable guidance for us, and we should be able to come somewhere in the middle of that.

Okay, that's helpful.

I will follow-up there on the electronics business.

Typically you see some type of seasonal uptick in the second quarter, particularly from a margin standpoint.

I think very few years have you seen a sequential decline in margins on electronics.

I'm trying to get a better understanding on what's driving the weakness.

How are utilization rates?

How do you view the channel from an inventory standpoint?

And then how should we think about that margin trajectory moving forward?

Joe, this is Nick.

We expanded margin here 60 basis points year on year against a quarter that was fairly strong, second quarter of last year.

What's been enhancing our margin and will continue to enhance our margin, is some of the portfolio management actions that we've been taking in that business that increase our cost competitiveness.

That's what's been driving it in the last few quarters and we continue to see that driving it in the next few quarters, Joe.

Okay, and then just a commentary on the end market from a utilization standpoint and from in inventory standpoint.

What is your sense for what's happening in the channel today?

As you know, we are spec-in on most of the devices in the industry.

What is happening from time to time is maybe a little bit of a delay of a new product introduction.

That will, of course, then impact us immediately.

I think the way I look upon this is to say we are making the same progress now is in the past relative to our spec-in.

And we didn't see any big change relative to inventory levels.

Which you maybe then also can see relative to purchasing.

If there was a little bit of a delay of some new product introductions and they did not build inventory.

They type of slowed it down, that is impacting us as well.

I will make the comment, though, on that business, if we just put it in perspective and why I am pleased with the performance there.

You recall that we started that business with margins around 15.7%, 15.8% or something, and now moved it up to 21%.

The question was always, is this volume driven?

My answer was always no.

The action we have taken on the portfolio, in order to get the more efficient organization, better lines to customers and have better asset utilization, meaning if we will have from a quarter that will happen in that business, a little bit slower growth, we will be able to hold margin at a high level, meaning it's not volume related.

I think we proved that in this quarter.

We proved that model is correct.

Volume went down a little bit, and in fact we had margin expansion in that business.

For that and on the work we have done our portfolio, I'm personally very pleased with what that team has done relative to that portfolio work.

That's a fair point.

Thanks, Inge and Nick.

I will get back in queue.

Thank you.

Nigel Coe, Morgan Stanley.

Thanks and good morning, guys.

I think if we back out electronics and energy, which is a bit more -- a little bit choppier around the quarters, I think the growth is the lowest we've seen since the recovery.

I'm wondering, Inge, some commentary on the macro environment.

Do you view this as a speed bump and we get beyond this end back into that 4% or 5% zone?

Or do you think there's something a bit more awry here?

First of all, I think let's hold it to the year where we start talking 2.5% to 4%, so we don't go ahead of ourselves relative to the future.

When I look upon it is to say first of all, United States is very solid.

We had a 4% organic local currency growth.

We grew in all businesses.

It is very solid.

As you recall, hopefully recall, a quarter ago that growth was slightly lower and the question was then, are you concerned about the US?

Our answer was no, not necessarily.

And I think we had 4% growth here.

That's good.

In Asia, or APAC, Japan did well.

Japan had 2% growth, excluding electronics, which is the base business, of 7% growth.

China was slow.

It slowed down.

They're type of adjusting to a new growth level there and we are now talking about mid single-digit for the year.

And I think we have to wait a little bit to see what will happen there.

It's a big economy as you know.

We have a strong position, but I think that growth needs to pick up more, specifically in the domestic markets.

Health care did well for us there.

The other businesses went basically sideways.

West Europe, we all predicted that there will be a growth pick-up based on the euro situation.

So far we have not seen that, and probably will come later in the year, but I think it will be very late in the year.

Latin America is doing fine.

And as you see again, Mexico had 17% growth.

That was the first quarter in many quarters that we saw a slight improvement in Brazil.

And as Nick said, Venezuela is now behind us in terms of comparison, where we will go into Q3.

So I think that's my view on it.

So I will say, I will not talk about higher figures than the 2.5% to 4%, at least as we go in for this year.

Then we will have to see how Q3 and Q4 will work out here.

Okay.

Inge, thanks for that commentary.

You mentioned let's see how 3Q looks.

You gave some good color on the last call on 2Q trends to date, which turned out to be pretty prescient.

So, how can we --

Can you repeat that?

On which one?

I'm just wondering how is 3Q tracking?

Nigel, we're not really seeing any change in trends from what we saw in Q2.

We saw things pretty stable within Q2 and we're not seeing, so far in the third quarter, any change in that pattern.

Okay, that's very helpful.

And a quick one on health care.

You mentioned drug delivery as being part of base and being weak, and that was a factor last quarter.

If we back out the impacts of drug delivery, how does that look?

How does health care look ex that?

That business in total, Nigel, brought down the growth for health care by approximately 1 percentage point.

Okay, that's very helpful.

Thanks, guys.

David Begleiter, Deutsche Bank.

Thank you, good morning.

This is actually Jermaine Brown filling in for David.

Two questions.

Your gross margins in Q2 expanded only slightly more than Q1.

For H2 should we expect a greater raw material benefit?

Or is Q1 and Q2 a good guide for what we should expect for margins within the second half?

We see the raw material benefit being pretty evenly spread between first half and second half.

I would say the first half is a very good guide for the second half.

Understood.

My second question is your demand within Asia-Pacific, particularly China, decelerated.

I'd imagine that some of that was due to lower electronics demand.

But were there any other businesses or end markets that also contributed to that decline?

Our declines there, we were up in our health care business, electronics and energy was, yes of course, one of the declines.

The others in China/Hong Kong were a deceleration from the growth we saw in the first quarter.

Okay.

And then one month into Q3, what are you seeing demand-wise within Asia Pacific?

As I said earlier, what we're seeing in Q3, so far no change in trajectory from what we saw in the second quarter -- or for the first half.

Understood.

I will hop back in queue, that's all that I have.

Thank you.

Steven Winoker, Bernstein.

Thanks and good morning, guys.

Could you talk a little bit about -- I want to dive into Capital Safety a little bit since I have not had the opportunity to do much of that.

You talked about, in the release, 14 times EBITDA multiple, I think that included synergies.

It's clearly a very -- at least I think it's a very attractive company and segment.

But talk through, number one, what was that multiple excluding that impact in that one-year timeframe?

And how do you think about pricing in general, given that you're obviously allocating more funds to bigger M&A?

I'm just trying to get a sense for how you thought about the return profile on that one and in general.

First of all, the Capital Safety is, in our view, a perfect fit for 3M.

Fall protection, which is the segment, is among the fastest-growing and most profitable segments in the PP industry.

Capital Safety is recognized as a leader in fall protection.

So you take those things together, there is high complementary synergy to 3M's global business in personal safety, which is a heartland division.

So Capital Safety, if think about it, it provides accretive growth to us and also margins, both for safety and graphics and for overall 3M.

You saw the slide again for safety and graphics which is very, very good, and have as I said earlier, is the business group that I thought will have the real break-out as we go.

I think it is a very valued and good acquisition to us.

The component annual sales growth had been over 10% for the four last years and EBITDA margins is approaching 40%.

You have all those types of things that you lay them back to the portfolio work we did where you say, how can we build out our businesses and make sure that we get more relevance with our customers as we move ahead and drive synergies?

What I think about it in totality, and the figures you are quoting there is correct, is actually 12x based on five-year run rate synergies.

I think this is for us a terrific acquisition that is building out our position.

Okay.

And so do you think about it in terms of return on capital over that timeframe as well?

Certainly, Steve.

We're looking at return on capital and looking at the time it takes us to bring this back to a return on capital.

For us that's in the fifth or sixth year that we see this meeting, on a cash basis, our cost of capital.

Okay.

And then on the pricing versus raws, you already talked about the raws comment.

Pricing was another 1% again this quarter, very strong, obviously dealing with FX and issues.

Can we talk about the sustainability of pricing within that equation going forward.

On the margin front, just to clarify, of that 150 basis points about 60 of those basis points are coming from our price growth, and 90 basis points from our raw material reductions.

As far as the sustainability of price, we're at a 1% price increase on average through the first half of the year.

We see that trend sustaining through the second half of the year.

Okay.

And is that mostly, again, that's independent of new products.

It's just pure price increases on existing portfolio?

On our existing portfolio.

I would add the color that if you look at all of our price growth, the fact that we keep refreshing our product line with our investments that we're making in research and development, that does enable us, through the value we are creating for our customers, to be able to sustain pricing growth.

But the other part of our price growth in the second quarter and for the year is also driven by movements related to FX.

If I look at second-quarter standalone, of our total price growth, we estimate 25% of that total price growth is coming from pricing based on the value we are creating for our customers, and 75% based on movements we're taking directly or indirectly related to FX movements.

Okay, that's very helpful, thanks.

Scott Davis, Barclays.

Good morning, guys.

I was a little bit surprised in Capital Safety you said year five or six reach your cost to capital.

I'm assuming your -- and I'll ask the question what you think your cost of capital is, but let's just say for the sake of argument it's somewhere in the 9% range.

I would think when you're buying a business like this in an industry you know so well and so easily integratable, that you'd be able to earn a higher return on that.

On the other side of it just indicates that maybe you overpaid.

I hate to be skeptical on that stuff, but can you address it a bit?

Part of our portfolio prioritization is we know the assets we want to buy.

We know where we can drive the most value.

As we look at this business integrated with our personal safety business, we do see cost synergies that we'll be deriving.

We see sales synergies, both of those contributing to get that result.

What you're seeing here, Scott, is a result of us having a clear vision of what we wanted to add to our portfolio, and also an asset that we could see bringing a good financial return to 3M.

I think that partially answers it.

Partially what I'm saying is if you look at future acquisitions, is this going to be the type of hurdle rate you're looking for going forward?

Because from my perspective, is all you can do is earn 8% or 9% return five years out and there's risk, you could probably get that just buying your own stock.

Also to that it is not necessary, Scott.

I think you have to look upon this -- first look upon this acquisition first of all, clearly strategic in terms of the outcome of the portfolio work, right?

I think that's an important element.

There are certain pieces of the business that can be integrated and where we can drive synergy, others cannot.

The reason for that is that there's a high element of regulation and education in that fall protection.

We need to continue to invest in that and make sure that we do everything that is right.

There's two elements into it.

Some pieces from the commercialization perspective where we can drive a lot of synergy, and we will.

And the other piece, I think we still need to figure out how we can accelerate that to get the return even faster.

It's a highly regulated business, as you know.

And then by that, the advantage of that, the barrier to enter is very high.

You have to think about it, you get it integrated and as you move on it, you have to make sure that you can drive more synergy.

The answer to your question, necessarily not.

This was a specific case.

This is a very important strategic move for us in order to build out our position here, and it is a high-class asset.

It is a high-class asset that is very similar to 3M in terms of margins, returns and growth and so forth.

So we can always --

I agree.

I think more specifically, just trying to get a sense of the future.

The other thing here, Scott, if you look upon the other acquisitions we have done from Sumitomo to Ceradyne, et cetera, we are not even close to this.

I will say that, we can always argue day out and day in, of the valuation.

Did you pay too much or whatever?

This is a strategic fantastic move for us.

We have a world-class asset.

I'm pleased with that piece and now it is up to us to drive the return even faster back to us.

Okay, that's a good answer.

Just to be a little bit more, dig into a little bit more detail on that, you mentioned EBITDA margin of 40% on Capital Safety.

Can that be a 50% EBIDTA margin business?

Or is it more a function you can bring Capital Safety in and the rest of your safety products business is co-opted?

Or is it Capital Safety itself can see a margin lift?

Scott, we see modest gross margin expansion opportunities there.

We probably see more of our cost synergy benefits coming from the back office SG&A front than on the gross margin front.

Okay, that's helpful.

Thanks, guys, I will pass it on.

Deane Dray, RBC.

Thank you, good morning, everyone, and let me say congrats to Matt and Bruce on their new responsibilities.

Sorry to pile on the Capital Safety deal, but this was the largest deal you have ever done.

And if I'm not mistaken, this was not the first time you had the opportunity to buy this asset.

Why did you pass on it before?

And then you are already in fall protection because I've been to trade shows where we've had the demonstrations of fall protection.

So how does Capital Safety expand your product line?

And where might there be overlaps?

You're right, Deane, that we had a small presence in that segment.

We were very, very small.

And one thing that I have learned over the years I've done business, if you do not have a reasonable good market share position, you will over time lose out.

I've been in businesses over time where you think that a couple of percentage market share will take you to a better position.

Is a very, very tough, so you need to come into a leading position.

That was one.

Yes, we were there.

We were, in my view, not relevant enough for the industry.

So very opportunistic.

Now let's go back to your comment relative to why now.

I talked about it in my speech before, but I have to go back to it because I think this is an important element.

If you don't have a clear picture of where you would like to go in the future with your portfolio, you could have a tendency to try to be part of auctions of most things that are becoming available.

If you are part of bidding on more things that are becoming available, you maybe do not really know if this is a real important strategic imperative for you, and you should go for it.

I would say, I was not part of 2008 and 2010, whatever, when there was bids on that asset.

But maybe at that point in time it was not clear enough relative to the portfolio where we should invest for the future.

This time, it was very, very clear for me where we should go.

That's the answer for me.

Inge, thanks for that context.

Just one follow-up on the Mexico organic revenue growth, 17% really jumps out.

What was driving that and expectations for the balance of the year?

Mexico has now been growing for almost two years, doing very, very well.

It's, I would say, a combination of both domestic market growing well there, but also the overall Mexican economy in terms of exports, specifically into the United States.

We have a very good portfolio balance in Mexico.

As you know, we've been there for a long time and we're able to capitalize on that.

I don't know exactly if I can give you the -- No, no, his question is about the outlook for the year in Mexico.

I think our growth rate here today is around 15% and I don't expect for the rest of the year that would slow down.

All businesses doing well there and specifically industrial is growing very, very fast.

Thank you.

Shannon O'Callaghan, UBS.

Good morning, guys.

On this China expectation for the year up mid-single digits, China/Hong Kong, it was up 7% in the first, down 2% in the second.

What gets better from here to even get you to the mid-single digits?

You talked about some inventory channel adjustments.

Any other color on what you expect to improve from the current rate?

I think that, first of all, I believe that health care will continue.

What a good quarter in health care.

Health care will continue and consumer will improve specifically.

I also think that the industrial business, that is a sizable business for us there, will improve slightly as we go for the year.

When you think about our portfolio, we get industrial slightly better.

We get consumer up a little bit, which we will.

And then health care continuing.

That will take us there.

I don't comment on electronics because, as you know, electronics is that kind of business that is on a regional base.

Sometimes Japan is doing better than China and so forth.

Let's see how much that will be executed in China.

I think there's still a time here that we have to see the adjustment in the Chinese market.

But those three businesses specifically will improve for us slightly as we go for the rest of the year.

And terms of those improvements in industrial and consumer, is that based on timing or ending of channel reductions?

Or is this improvement in the economy?

Yes, that is what we are counting on.

We cannot count on anything else.

That is what we are counting on.

The channel being cleared out and getting back to more normal?

Yes.

Okay, and then within the industrial business.

All the end markets you commented on sounded reasonably good, but the whole segment grew 1.4%.

Was there anything within that segment that was dragging it down from the decent trends in auto and other stuff?

Yes, our industrial adhesives and tape business within industrial, that's one of the businesses that was flat.

That contributed to bringing the total organic growth down.

Abrasives is another business that was down.

And that is going to a ton of different end markets, right?

Stuff doesn't go always down to one thing, right?

Exactly.

Including, in the case of abrasives, there's some oil and gas exposure there.

Okay, great.

Thanks, guys.

(Operator instructions)

Andrew Obin, Bank of America Merrill Lynch.

Hey, guys, good morning.

Just to clarify on the Safety acquisition, you said it's going to be dilutive in the first 12 months.

When are we expecting to close it?

In the third quarter, right?

Is that dilution Incorporated in the updated guidance?

Andrew, yes, we've said that for the first 12 months we expect this to be dilutive to GAAP EPS by $0.04.

We expect this to close in the third quarter, in the middle of the third quarter, and our guidance is not yet including the impact of either the Capital Safety or the completion of the Polypore acquisition.

And just to clarify, in terms of oil prices have been coming down quite a bit since the end of the quarter.

And I know you've updated what you think the impact is going to be in terms of your inputs.

But when did you update your outlook for oil prices?

Is it updated for the decline that we've seen over the past several weeks?

Yes, it is updated.

And similar to what I said in April where we see ourselves now at the high end of the range of $0.25 benefit on raw materials benefits as well as the margin impact I talked about earlier, that's reflecting where we are most recently with commodity prices.

So yes, it is reflecting that, Andrew.

And just a broader question.

All of a sudden North America, US, is the fastest growing market, has lower margins, emerging markets are slowing.

Are you thinking about adjusting your longer-term plan, given where the macro is playing out?

Or do you think the existing game plan is adaptable to what you're seeing?

Yes, the existing game plan is adapting to what we are seeing.

There's no change from that thinking at that point in time.

As you know, if you think about the five-year plan, we are three years into it.

There's always some changes going in and out in the plan, in terms of all metrics.

At this point in time -- of course from an execution perspective on where you invest for manufacturing and so forth, there are some differences now versus what they were three years ago, or where will you invest in international, or will you do it in the United States.

I think that's a business call on a day-to-day business.

At this point time there's no change from the overall plan, and our play-book is working.

Our play-book is working.

Terrific, thank you very much.

Steve Tusa, JPMorgan.

Good morning.

Back to Shannon's question, but at a little more of a broad sense.

Can you give us a little color on what you would expect on a core basis for how the third and the fourth quarter play out?

I know that you have a little bit of an easier comp in the third, and then a tougher comp in the fourth.

I'm curious to see, to his question, just more broadly, what gets better here from the 1.8% that you put up this quarter.

Okay, Steve, just to clarify, you're talking about total Company?

Total-co or core.

So the 1.8%, what does the 1.8%, how does that trend in the third and the fourth quarters?

Is it steady or a little bit better in the third?

Worse in the fourth?

And our 2.5% to 4% I can't say we're seeing a noticeable difference between third and fourth quarter, if you're looking for some color on that, Steve.

On the low end of the range it would be a continuation of the growth rate that we've seen in the first half, that continues into both the third and fourth quarter.

If we're a shade towards the middle or the high end of the range, we would expect to start to see that occurring in the third quarter and not all in the fourth quarter.

Okay.

And did things get -- how did things trend as you went around the quarter?

How was April, May, June type of dynamics?

When we look on this on a sales per billing day, we saw virtually no change in our trends between the three months of the second quarter.

Okay, and then one last question on the pricing dynamics.

I guess you said 70% or 75% of that ForEx related.

As we lapped these ForEx comps as we move into next year, I guess you're going to have a first-quarter comp.

So does that mean that 1% is probably -- since your second half is probably going to be a little bit less than 7% year over year, I guess, on ForEx?

Does that mean that 1% starts to fade in total as we move forward?

To the extent that there's a portion of that 1% related to FX over time, I see that fading, but not in the second half of the year.

If it does fade, it will be minimal.

The logical extension is we see some fading of that in 2016, not a material amount of fading in the second half of 2015.

And on the 4Q in US, is that a good kind of reflection on -- the US is probably your most stable market.

Is that a good reflection of what you're seeing on the price inflation side?

Presumably customers will come back seeing what you guys are doing on the raws side.

Is it a little bit tougher to get price these days because of what's going on with raw materials?

This is more of a macro question, I guess, as well.

You would assume it would be, but I think one of the advantage for us is that often our product is adding some additional profitability and productivity to our customers.

So I would say, yes, a little tougher.

But as long as you are focused on new product that's adding value into the end market, you are able to demand a slightly higher price.

Right, great, thanks a lot.

Julian Mitchell, Credit Suisse.

Thanks.

I want to follow up on the industrial business.

You talked about some inventory issues there in the second quarter.

I just wondered how severe those were and if you thought that inventory had largely been cleared out, so in the third quarter we should see a better industrial organic growth rate.

I would say that I think it will be cleared out, early Q3 is my view.

I think when you listen to the results for the industrial and many businesses did well.

There's a capital business that I will describe more as they're not spec-in, or designing, they're more in the consumable side like abrasives and tape and so forth.

That's where we had a little bit of temper and I think that then holding to the channels.

I'm more optimistic as we move forward relative to that front for industrial.

The other businesses there, if you think about aerospace and commercial and transportation at another 10% growth, purification another 10%, automotive OEM, as Nick said, has 6%.

So many businesses there are doing very well.

There were two divisions that had an impact for the quarter and it was very much what I would describe as consumables into industrial tapes and adhesives and abrasives.

Thanks.

And then my follow-up would be on the free cash conversion.

Is it just the tax normalization in second half that pushes up the conversion?

Or is there something else happening with working capital, for example?

Julian, there's a few things at play here.

First of all, when we pay our cash taxes there is some timing, and second quarter happened to be heavier weighted.

That will moderate for the total year.

Second quarter was also a quarter of higher than normal amount of our total pension contribution occurring in the second quarter.

And then the last piece is we did see some increases in our working capital and we expect that also to moderate in the second half of the year, all of the three of those contributing to improvement in our working capital into the second half.

Those are what I'd adjust for.

We have normal adjustments where, for instance for compensation, that always has a noticeable improvement in our free cash flow conversion in the second half of the year versus the first half of the year.

Great, thank you.

Laurence Alexander, Jefferies.

Good morning, two quick ones.

As you look across your portfolio in terms of where you either have a stronger new product pipeline or a high degree of confidence about pent-up demand, do you see any line of sight for acceleration in 2016, 2017 in any of your larger product categories?

And secondly, if this choppy, soft demand environment continues for a few more years, how does that affect, if at all, your balance sheet targets?

Nick will give you some comment on the balance sheet.

Let me address the comment relative to the, let's say, business groups.

First of all, there is a very robust pipeline of new products in each an individual business groups.

I don't see, from that perspective, a difference in between them.

But when I look upon it, we have some businesses here that is -- industrial is 33% of our portfolio, and very strong.

And we are now adding, even, an acquisition into that moving forward.

And I think that what I call a design or spec-in there is a very strong credible business.

I think it will be strong.

I think, as I said earlier, safety and graphics, I talked about that for over a year now, that I believe that safety and graphics is the next breakout business group for us, as electronics and energy came earlier.

The margin has expanded quite a bit there and I predict that safety and graphics will follow, and maybe do even better due to the fact of the portfolio there.

I'm confident that will happen.

And you see our health care business.

Health care business is usually the fastest growing, highest margin for us.

And 80% of that portfolio is in the developed world, meaning only 20% in the developing, and that way a lot of growth for us is coming.

Again, I would say, yes, when I look upon it and try to be objective, you see the performance of our consumer business.

Again, with a very good growth I would say, and margin expansion and a very strong brand equity.

So I would say for the future for what we're doing here, I'm optimistic.

And it's been a lot of work on the portfolio side, get more efficiency and organization, try to reduce unnecessary variables internally.

And as we say here at 3M, that the productivity is important and complexity is the biggest enemy of productivity.

And the whole team is working on that big time.

I would not make a distinction in between there.

We are in a good position everywhere.

Laurence, just a follow-up close on the last piece, you were asking about the balance sheet.

Our strategy with our balance sheet, as far as our capital structure and our allocation of capital, we see our strategy there robust enough to encompass a number of business models, including a lower growth scenario.

On the margin, what would change, and again, this would the volatile of exactly why we're seeing a lower growth world.

But for example, CapEx, our capital allocation strategy, I think it would be natural to assume there would be less of our capital going into our CapEx capacity building.

In terms of M&A, that would depend on our view of the valuation of the opportunities.

It could have an impact where things become more attractive to us, but that's highly driven by the opportunities that we see presenting at that time.

Laurence, this is Matt.

We wouldn't see anything changing in terms of organic growth being the primary way in which we grow.

We obviously dial CapEx to whatever levels of growth we're seeing, but it doesn't fundamentally change the way we think about growth, acquisition versus M&A.

Thank you.

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

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

Thank you very much for participating this morning.

We look forward to seeing you very soon.

Goodbye.