3M Company (MMM) Presents at Citi 2023 Global Industrial Tech and Mobility Conference (Transcript)

3M Company (NYSE:MMM) Citi 2023 Global Industrial Tech and Mobility Conference February 22, 2023 1:50 PM ET

Company Participants

Mike Roman - Chairman and CEO

Monish Patolawala - EVP, CFO and Transformation Officer

Conference Call Participants

Andrew Kaplowitz - Citi

Andrew Kaplowitz

All right. Good afternoon, everyone, again. We'll let a few stragglers come in here, but we'll get started here. We're extremely excited to have 3M with us today. We've got Mike Roman, who is the Chairman and CEO; and Monish Patolawala, who is the EVP, CFO and Transformation Officer.

Mike became CEO in July of 2018; Monish, CFO in July 2020. So Mike, as I walk over to you. I know you want to talk about a few things. So I'll just turn it over to you, and then we'll get into a fireside chat.

Mike Roman

Yes. Thanks, Andy, and thanks for hosting us. It's a pleasure to be here. Yes, I thought I'd just do a quick review of 2022 and then I'll look into '23 and kind of kick things off.

So 2022 was a pivotal year for 3M. We not only took actions to manage through some challenges during the year. We also made some big strategic decisions and initiated strategies that are going to be foundational for the future of 3M. Now like everyone, we were managing inflation with pricing actions and cost management and sourcing strategies.

And we navigated the supply chain disruptions really with a focus on our customers, something we talked about during the year. We spent money on to make sure we deliver for customers, including adding a distribution center on the East Coast so that we could access some of the logistics alternatives that we needed.

We also navigated the COVID lockdowns in China. We worked with Flemish authorities to reopen and restart our operations in Zwijndrecht and we exited our business in Russia.

So a lot of actions during the year. And we took some big strategic decisions, too. We divested our Food Safety business, which we received $1 billion in cash and retired 16 million outstanding shares as part of that process.

We continue to make progress on our -- spin of our health care business. And as I have noted before, this is still subject to regulatory approval and tax rulings and Board approval and other customary closing, but our team is making good progress there. We continue to support Aearo Technologies as was in the press last week in confidential mediation in their Chapter 11 proceedings and negotiations.

And we continue to manage PFAS -- the PFAS litigation, defending ourselves in court and resolving and through negotiation where appropriate. And notably, at the end of the year, we made an announcement to exit all PFAS manufacturing by the end of 2025.

So really important year. And as I turn to 2023, I -- we look at the year as seeing some of the same dynamics that we saw coming into the end of 2022. So a challenging year. We came out in our earnings call in January with a guidance, organic growth of minus 3% to flat.

This is reflecting the end market dynamics. It's also reflecting about 200 basis points of headwinds from disposable respirators coming off of the Omicron surge in demand a year ago and coming off the pandemic demand for disposable respirators to more of a more normalized safety business. And then we also had that exit of Russia. So that's about 200 basis points. We have overall EPS in the $8.50 to $9 a share. And that includes a number of items that are headwinds. We have the Russia and disposable respirator headwinds on the top line and the impact on the bottom line.

We have FX in $0.10 to $0.20 range on FX. And then we have the divestitures, I talked about hitting us about $0.15 so puts us in that guidance range. And then we expect to deliver 90% to 100% of free cash flow. So it also reflects, I would say, what we see as a challenging first quarter to the year.

We see some of the same dynamics that we called out at the end of the year, hitting us in the first quarter. The consumer electronics end markets down, negative growth in those end markets and continue to play out in the first quarter and first half of the year.

Consumer -- Retail spending. While retail spending has been holding up, you see that in the news. It's shifting to food and experiential spending and away from discretionary products. And so we were seeing that at the same time, retailers are taking action as they see that shift and they're driving out inventory.

So we saw that in the end of 2022 and carrying into '24. So those are dynamics. And we actually don't do this, but we -- as a regular course, but we guided first quarter because it was such a challenging first quarter. And so excluding PFAS, we are in a range of $7.2 billion to $7.6 billion in revenue.

We have EPS between $1.25 and $1.65, midpoint of $1.45. And really some of those same challenges in the first quarter impacted even more heavily by disposal respirators and Russia. We suspended operations in Russia and eventually exited as we went through the year.

But first quarter, we had that business as one of the headwinds this year. So a challenging first quarter. We have been taking actions as we saw the slowdown last year. We're not satisfied with where our performance is today. So we continue to take additional actions. We announced in our earnings call, a reduction of 2,500 positions in manufacturing to adjust to that volume outlook that we're talking about.

So flexing as we see the volume demand and really taking action to take that on directly in that -- in those costs. And then we said that we will be looking at everything we do as we work through the spin. This is an opportunity for us to look at how we focus on ParentCo at the same time we work and -- focus on SpinCo.

And so we're looking at all the things that we can do to simplify streamline and get closer to the customer. And we expect to take additional actions as we go through the year. So it's -- we are -- we'll lean into additional actions as we go. At the same time, we continue to invest in innovation and growth.

We see opportunities, high-growth market spaces that can leverage our innovation areas like automotive electrification, industrial automation, biopharma processing, home improvement, all areas that are opportunities to take advantage of 3M invention and innovation and enables growth.

And really delivering and improving our performance, a big part of it is going to be our ability to drive volume. So it's an important part of what we do. So I sit here today, I'm really confident in our future. And I -- as I said in our earnings call, we expect to -- as we go through the year and exit '23, we'll be a stronger, leaner and more focused 3M going forward.

So I'll frame a little bit from the earnings call, but I think also really frame up of what we're doing and how we're focused on execution in 2023.

So Andy, I'll turn it back to you for questions for Monish and myself.

Question-and-Answer Session

Q - Andrew Kaplowitz

Yes. Mike, very helpful color. You basically answered my first question, but I'll ask it to you, maybe just in a quick follow-up. So you kind of reiterated the guidance for the year and for Q1.

But just in terms of the nuance here, I know you -- when you reported, you said industrial was mixed with some weakness in destocking, especially related to electronics market. So -- and you said January overall started slow. So can you give us a little update on whether February continued with slower activity?

Any sort of commentary from customers and how you're thinking about sort of the overall environment as you go through the quarter?

Mike Roman

Yes. So 7 weeks into the quarter. I would say it's playing out as we expected and some of the dynamics I talked about consumer electronics, consumer retail, those are continuing to be soft.

Consumer electronics of anything is getting -- the end markets are getting softer in demand. We did start off with a slow January. China had decelerated in Q4 and was soft in January as well. And we did see mixed performance across our industrial markets, I would say.

And some of that, we did see some destocking in industrial channel. Most of it is really around caution ahead of the outlook for the year. There are some specific areas where we saw destocking in Asia with some of the industrial demand softening there.

We saw destocking there. We also saw some specific end markets, not the largest end markets, but we saw some destocking areas like specialty vehicles and construction and a few areas like that where we saw a soft start to the year. So we're -- areas like China, we're like everybody else, we're looking at and watching closely what happens in the economy and the market segments that we play in as we come out of Chinese New Year.

And there's some hope is that, that will get better. Certainly, the projections are for the macro GDP, IPI to improve in China as you go through the year. So we'll be watching that closely. There are some spots that are continuing to perform. Automotive build rates, sequentially down from Q4, but it's a build rate -- projection for build rate growth is almost 4% in the year and continue to see that as something that is a positive in the end markets. But I would say, soft start in line with what we had expected.

Andrew Kaplowitz

Got it. Maybe just 2 quick follow-ups, and I'll leave the newsroom alone. So like -- have you seen any broadening though in destocking in industrial? Is it kind of still kind of niche? And then China, have you seen anything post Chinese New Year? Is it still too early to know...

Mike Roman

Yes. In China, it's too early to tell. It's -- we're -- like I said, we're watching it closely and looking for kind of a better, broader indication. Destocking -- we started Q4 in pretty good position. The one notable was retail. It was destocking hard at that point, and we were in the middle of that, that has continued.

I think that will play out through the first half. I think there is a lot of focus on that going into the end of the quarter for the retailers, but it's going to continue to play out. The destocking and industrial, I talked about it, it is not when you look broad-based, it's not a deep restocking.

You think it's cautious against the outlook. Other places are balanced. We -- I would say, health care against the elective procedure is expecting to improve is pretty well in line. So it was -- the notable ones are the ones I talked about.

Andrew Kaplowitz

Got it. Okay. And then let's step back. So priority; is like, I think your #1 priority is to grow faster than your markets, right? And so if I look at you guys since 2019, since before the pandemic, like you grew but you averaged kind of less than 1% growth.

And your competitors are kind of 2% to 3%. And again, that includes a lot of volatility around the pandemic. So what do you think 3M needs to do to improve, to accelerate growth?

Mike Roman

Yes. I think it is what we do in our model and doing it better all the time. But I would -- just a level set. I would say, if you look at -- since 2019, so your '19 to '22, we were about 2% growth ex DR and almost 3% with DR in the ups and downs that we saw in the pandemic. Since 2020 we are more like 3% growth ex DR and over almost 6% growth with the -- excuse me, 3% including DR and 6% ex DR.

Yes. So there's been good growth dynamics. The point is, since the last couple of years, we've been performing well in our growth dynamics. We certainly saw the impact of those end markets last year. But it's -- and it's -- and the pandemic certainly had some ups and downs in that.

So there's some -- within all that, there is examples of what I would say we're doing to drive growth, and that's investing in the high-growth market spaces in the attractive parts of our portfolio where we can differentiate ourselves with our innovation.

And we've got a number of large commercial platform areas that we talked about as we went through the last couple of years that we're investing in organic growth. And driving that organic growth areas like automotive electrification. You and Andy had a conversation, you said automotive electrification gets to be a $1 billion business. Then I start to think it could be a $2 billion business, and it's interesting.

Well, it got to be a $0.5 billion business last year with 30% growth. So that's an example of where we can invest and drive market growth and create value for our customers. We have our home improvement platforms that are more than $0.5 billion each. And in key areas and key trends, they're going through some of the same retail spending dynamics, but our filtrate -- home filtration products have normalized and are -- we see these as areas where our science and innovation makes a difference, and we can drive growth and value.

And we have other areas that we are investing in electronics, safety. In health care, we have areas like biopharma processing, which I mentioned, but also advanced wound care. These are all significant commercial platforms that leverage 3M innovation and enable us to add up more of the portfolio that can help drive us GDP plus, IPI plus, deliver above the macro growth. And give us an opportunity to leverage that into margin improvements and strong cash flow.

Andrew Kaplowitz

So let me just ask a follow-up there. Like, so you had your Investor Day. When was it? Like, early last...

Mike Roman

February. Almost a year ago.

Andrew Kaplowitz

And so like you highlighted a lot of the markets. You talked about, home improvement, health care IT, automotive, wound care, electronic materials. Like, we already talked about automotive electrification. Like, any -- so I assume that one is at or above sort of what you thought it would be. Any others that you would say have accelerated more than you thought? And any others that have been harder to really sort of move up on...

Mike Roman

Yes, maybe I'll talk about both sides of that. If you look at health care, a couple of things. I mean, we talked about health care IT I think, in that call. And our revenue cycle management, our 360 Encompass product has had strong performance. There's budgets and hospitals are impacted.

So the growth dynamic -- market growth dynamics aren't strong, but we're well positioned with that. Then our -- I would say, our clinical and computer-aided documentation capabilities, natural language processing, AI capabilities in our products that we've invested in. Those are -- we see that as providing a strong growth trend as you see health care markets get back to pre-pandemic kinds of performance.

Same on our wound care management. We had a wound care business. We made the acquisition of Acelity. In the middle of pandemic, procedures were down and that impacted those wound care businesses. One area of notable exception is surgical site management. And we have a solution that has been performing extremely well and helping to drive growth. But we expect that to perform well. And we expect that to continue. Our home improvement, just one other thing to note, even as the market trends have been strong during the pandemic, double-digit growth in those home improvement. And now seeing the impact of the shift to retail spending, we've been a category share leader and continue to be.

So those -- that's an encouraging part of that. Other areas -- general manufacturing, there's -- industrial automation, it's an interesting space. We have products in our Safety and Industrial business, our repair stack product and our automotive aftermarket.

Our Finesse-it abrasives in our Abrasive Systems business. Our Extrudable, very high-bond tape, [indiscernible] version that lend themselves to automation, and they're working with robotics and system integrators to really penetrate new solutions.

So we're excited about the growth opportunities that our differentiated performance in our material science enable in more of a digital automation kind of space. And there are -- our other areas are electrical and electronics.

We talked about the importance of winning in consumer electronics and continue to innovate there. When you look at the end market dynamics, even when we get through this slowdown, the build rates are going to be fairly nominal. But you -- the innovation is high value, and you can continue to keep your business growing at a nominal rate in that marketplace. The key is moving into other electronic segments. And we talked about automotive electrification, which is one of them. But data centers with our interconnect solutions and you look at semiconductor manufacturing and our pad conditioners, the technology, the material science technology we bring into that really enable the next generation of semiconductor fabrication.

So those are all areas that we called out, I think, a year ago and all areas that still are exciting for innovation, and we see as growth drivers. And they are, all that, $0.5 billion plus, but electronics are -- the VR, AR, ER space, it's the next -- the next horizon for our material science film technologies and will be a fast grower starting at a relatively lower level today than other display technology but going to grow very rapidly.

Andrew Kaplowitz

Interesting. So I already asked you about China. Like, just if I step back and think about the regions, you've said in China, EMEA, like geopolitical challenges will continue in Q1. But -- if I step back, North America and EMEA, like how do you -- what do you bake into guidance for '23?

Mike Roman

Yes. So the U.S. -- the dynamics we talked about are part of that, the macro -- if you look at the macro for the U.S., it's going from 3% last year, GDP, IPI to 1.5% this year.

It gets a little bit better as you go through the year. So we bake in that projection of macro into what we're thinking about that we've got those specific markets, that we called out in our earnings call is kind of part of how we were thinking about the whole year.

That's certainly true for the U.S. markets as well. EMEA, it's -- I would say, the uncertainty around the geopolitics, the energy issues that they've been facing now. We've had a warm winter, so that's helping, but it's just watching that and making sure that we are keeping track of how that evolves, not just judging it by a macro projection.

I would say that in almost -- in our markets, in our macro, we really build our view of the year around those kinds of projections, but then we watch them closely because they can change very quickly. And so I would say with Europe, that's also -- now Europe, interestingly starting the year with a strong performance in automotive build rates. So we're seeing some opportunity there.

Andrew Kaplowitz

Interesting. So this one might be for Monish, but you can certainly chime in too. It's around margin. So Monish, we asked you again at the same Analyst Day about sort of incrementals. You talked about 30% to 40% incrementals through the cycle.

Can you sort of do that? Like, this year, there are some utilization issues in Q1 [2023] . Can you do that in a world where you're getting out of PFAS, which I think can put some pressure on utilization you tell me, and where supply chain is still a little choppy.

And then I think you said at your Investor Day that you're focused on value stream simplification portfolio to increase margin. But again, there's a lot of macro noise. So update us on where you are on those things.

Monish Patolawala

Yes. So Andy, I'll start first by just saying mathematically that when we say 30% to 40%, I'd just break it out. You've got gross margin give or take, 45% to 50%.

So for every dollar of extra revenue, you get $0.45, $0.50. And then you say a piece of it, I reinvest back. That's why the 30% to 40% incremental is doable. To that, you add the supply chain efficiency that we get, whether it's using data, data analytics, whether it is helping to drive yield and efficiency in our factories, better utilization in our factories, all of them will add to that 30% to 40%.

You also sit back and say, "I can drive dual sourcing, better sourcing benefits." And then you take some of that savings and you say, I continue to reinvest in the business with growth, productivity and sustainability. And that's why in the long term, the 30% to 40% is doable.

What has happened in the short term, as you all know, is with the supply chain inefficiencies, most supply chains have gone through some pain. We decided through the pandemic that we would first focus on our customers and worrying about our own bottom line because we felt it was important that we had to take care of our customers.

So we air freighted stuff, we had short runs, all of that have impacted how our margins are shown. As supply chains heal, and it's going to be '23 and beyond. The first half is going to be tougher than the second half.

You should start seeing the benefits of some of these things starting to come through. That's why in the long run, I would say 30% to 40% is doable. The team has made good progress. The teams have continued to drive yield and efficiency in many of our lines.

To answer your specific question on will PFAS have an impact. Yes, it has an impact only on factories that are multimodal. But as we have disclosed, and you all should read the 8-K that we filed yesterday, which actually gives you the breakout of PFAS by year -- exit of PFAS manufacturing by year and the margin. You will see actually is margin dilutive.

So exiting that also should help. And the margin rate has got -- has diluted over the last few years because the investments that we have to make to keep that business running, the regulatory trends, et cetera, which is one of the factors that we factored in from a PFAS exit of -- exit of PFAS manufacturing. So I would say that to answer your question, that should be margin accretive when we are done with that.

Andrew Kaplowitz

Very helpful, Monish. So maybe just I'll ask a related question now because it's around selling prices and price versus cost, right? So I think you mentioned 2% selling prices in your guide. Commodities kind of all over the place, maybe rising again a little.

So is there any pressure to sort of continue with price increases? How do you think about the stickiness of prices if we go the other way? And then just, again, talking about the PFAS chemistries that you're getting out of, I felt like you guys provided good value, in quotes, with your PFAS chemistry. So if you get out of it, can you still provide value to the customer so that price versus cost stays green?

Monish Patolawala

Yes. So to reiterate, so in our guide, we said 2% selling price is built in. At the same time, we said the carryover impact of inflation -- because remember, first half of last year was very inflationary plus the higher utility costs we're going to see in Europe was at a range of [1 50] to [2 50].

So price -- we are managing inflation through price. If this turns out to be more inflation, the teams have the playbook that will allow you to go after more price. I think, Andy, what we'll all have to think through is if there's strong deflation very quickly, which I don't know it will be, because its -- inflation so far has been persistent and sticky. I think price elasticity discussions will start coming into many markets, not just with 3M.

What I would go back and say we add value to customers. When I've seen the history of 3M and certainly, when you look at the P&L, historically, 3M has always been able to add value and get a range of anywhere between 50 to 70 basis points of margin expansion due to price cost.

You have to exclude electronics and auto because historically those businesses have always been a price-down business. You get specced in and there's all the -- that's just that whole industry is based on that thing. And that's where innovation comes in.

Because the more you can innovate, the more you can maintain margin that, back to Mike's words, a portfolio innovation. They all are part of that whole exercise. And so I would say time will play itself out on how much inflation is there this year. This is what we see right now.

We are prepared to act either way depending on how it goes. And I don't think it's just PFAS that adds all the value, and therefore, our customers are paying us. The exit of PFAS is a 4% of our total business.

We add value to our customers in many ways. It's through our quality, it's through the product, it's through the innovation and most importantly, the partnership that we bring with solutions. So I feel pretty confident that that's not going to change. So therefore, as long as we add value, we should see the price cost equation play itself out to the positive.

Andrew Kaplowitz

Helpful. And then maybe another question on margins, just in health care specifically, right? So I mean health care was a very high-margin business. It's still a high-margin business. But maybe over the last few quarters, it's been ticking down.

Again, that's a little bit lower than it was a few years ago. And we know you sold the food business, that was high margin. The portfolio has been changing. But help us think about where does the margin go from here? Can it start to improve from here? And what are you doing to make sure that it does improve from here?

Monish Patolawala

Yes. So I'll start by first saying you got OI, but you need to look at EBITDA for health care because you've got 2 big acquisitions that we made, Acelity and M*Modal, both of them had pretty good pressure.

So if you just use 2019 as math, the OI -- the EBITDA is somewhere in that 29% to 30%. I think it was 29.5%. If you look over the pandemic in 2020, it was I think 29.2%. 2021 was a little higher. 2022 is in the 29%. If you take the quarter where Acelity got exited, which is third quarter, so the end of second quarter, EBITDA was also 29.5%. So we have remained in that range of 29.5% to 30%.

And a lot of -- all this data is available in the press releases that we give you also. It's -- you all should go and look at that. With that said, that business has got impacted by some of the raw material costs, the supply chain inefficiencies, inflation, they have managed it through price, but that's where the opportunity lies on the supply chain side.

With the gross margin that exists in that business, the volume will be the best leverage. Mike already talked about it. We have seen elective procedures have been 90% of pre-pandemic levels. Hospital budgets have been impacted by COVID. They are all running in negative -- many of them, negative operating margin.

The oral care business gets impacted by consumer sentiment because it's a consumer-ish facing business, but that's where the volume comes in. So when we look at health care in the long run, that industry is a GDP-plus industry. And as you get the volume come in, plus all the other things the teams are doing, you should be able to see that margin rate pick up. But -- what I would tell you is, as I mentioned through the pandemic, if you look at EBITDA, we have managed to at least maintain the margins in pretty much the ranges that I talked about. Would we like more, I think so. And I think as they keep using daily management, driving operating rigor, better factory productivity, you will keep seeing that go up.

Andrew Kaplowitz

So Monish, just following up on that, you mentioned daily management. That's one of your priorities as you came in that you kind of told us day 1. Digitization is probably the other. So what have those 2 things done for 3M so far? And maybe to use the American baseball analogy, what inning are you in of those two?

Monish Patolawala

So first thing is, I watch baseball, but I love cricket. But I'll still try to use the baseball analogy...

Andrew Kaplowitz

We got an international crowd.

Monish Patolawala

The best as I can. So let me start by just saying that we had laid this out. Our operating framework is based on 2 things. One is operating rigor, daily management; and two, is making sure that, most importantly, we're taking care of customers' solution. That gives us the best growth.

What operating rigor is based around is daily management talks about you've got to embrace the red, which is you admit you have a problem. You bring teams together and you get sustainable solutions. And in that, as we have gone through the framework, we have said the teams have got much better at calling out their issues early, which allows us as a team to all work together to find sustainable solutions.

We also have said, digital is a multiplier for us. And if you ask me where digital is in its innings of baseball, you're in the second innings or the third innings. There's a lot we can do. There's a lot of good data available at 3M, and we break our digital into 3 or 4 different pieces.

The easiest one is to talk about digital enterprise, which is ERP. Most companies talk about that and say, do you have an ERP, does it work? The second is digital operations, which is, how do you use data and analytics to improve your factory yield and productivity?

For just, as an example of pandemic, when we were able to increase the output of disposable respirators, [Manifold], we were using Digital Twins that told us how to you run these factories better. Then you go into digital product, take our health information systems business, which is basically providing a product as a solution to help customers with billing cycles in hospitals.

And then the last one is digital customer where you're actually making sure it's easier for customers to do business. So think about the omnichannel in our Safety and Industrial business. Think about e-commerce, where we sell on Amazon through our consumer business, et cetera.

So in my view, that is clearly an area that as long as you can use data and data analytics and provide solution to customers, digital will be a multiplier. And operating rigor is a place that I would say are daily managed and never stops, Andy. That's a part of this whole continuous improvement.

You always got to be able to look and say there's more we can do, we will do. There are pockets of the company that do it very well. There are pockets of the company that are continuing to get there. But I think we have got better at agility we have got better at predicting.

We've got better at bringing teams together and mapping end-to-end. But with all that said, as Mike said, I mean, there's tremendous opportunity. We are not happy where we are. There's a lot more we can do and we'll keep doing it, and we'll keep driving it.

Andrew Kaplowitz

That's very helpful, Monish. And Mike, you said, I think -- you took the restructuring in Q4, as you said. But could you elaborate on what you meant by saying that you're examining all aspects of the business in preparation for the health care spin?

And what further actions you could take? I mean, you said you see an opportunity for the streamlined supply chain and to further simplify, so what does that all mean?

Mike Roman

Yes. I would say some of the actions, like the 2,500 in manufacturing, that's really about the macro and what we face on the volume that we're looking at.

What I was talking about in terms of looking at everything we do, it's -- as part of the spin, we are looking at what -- what is the path to standing up a successful stand-alone health care company. That's a big part of the separation team's efforts and focus.

At the same time, we are learning and focusing on what is going to be important to do in terms of positioning ParentCo for success as we move forward. And those are future looking and not that far in the future as you think about working through the preparation of the spin. But they're future-looking and they're giving us insights into the kinds of things that we can do to improve our supply chain.

We -- if you look at the opportunities that we have to deliver improved performance as we go through the year, volume driving greater volume is an important way. It's our best leverage of improving margins and cash flow. We think we have a lot of opportunity in the supply chain.

We have an opportunity in just optimizing what we do. And I would say the work we've done in referring for spin is giving us insights into how to think about the supply chain. And our team made some changes even as we restructured and focused on addressing the macro as we came through the end of last year. They were looking at the things that we can do to position ourselves better for the future, plan, source, make, deliver, how do we optimize that even better.

And that will require also to some degree that we streamline the company and it's pointing out opportunities we have to streamline the company in some of the things that we historically have done in our commercial operations, in our supply chain operations. And also, how do we get closer to customers?

So it's -- these are actions, restructuring actions, I would say its actions to improve processes that we have. It's making changes that optimize what we do in our model. Our -- we've got -- great strength is at the heart of our model. Delivering those to customers, delivering that value in terms of our performance for shareholders, that's what we're looking to do. And we're learning from the process on the spin on things that we can step into.

Andrew Kaplowitz

Mike, I want to -- I'll ask you one more question and then we'll open up to the audience and maybe I'll pick up more after that. So just focusing on cash flow for a second, guidance is 90% to 100% versus 82%, I think, in '22.

Levers you can pull to get back to that? And then -- we have received many questions over the last year. Let's say, what circumstances would you pull back on things like CapEx, R&D, dividend to conserve cash? I mean, obviously, you're spending on separation costs, getting out of PFAS, have a drag from continued liabilities, we all know that.

So like, I get the question a lot of what does 3M do with all of these sort of whether it's CapEx divided or -- so how do you respond?

Mike Roman

Yes. I think there's 2 parts to that, maybe I'll touch on. One is, I'll take us back to the announcement of the spin of health care. An important part of that announcement we talked about we are going to create 2 world-class companies. And it was important that we position both those companies for success in a successful future.

And part of that was making sure they are well capitalized to execute their strategies, to capital allocation. We talked about our plans to have 3 to 3.5x leverage on health care and also to take an equity stake in ParentCo. And what that did was that sort of leverage position health care to be able to execute the capital allocation strategies, their strong cash flow driver.

They'll delever quickly. They'll be able to manage that and be successful in executing at the same time. It takes a strong balance sheet and 3M, and ParentCo that makes it even stronger. And so we position ourselves to execute the capital allocation strategies that we talked about. And our priorities, I don't see them changing.

I mean, they are, first and foremost, investing in organic growth of the business. We can continue to drive R&D, CapEx as we move forward and a strong balance sheet will position us to be able to do that.

Now near term, we're focused on going back to 82% and our plan for 90% to 100%. We have an opportunity to improve our free cash flow conversion.

And one of the biggest opportunities we have is in working capital. So back to our discussion about what are the things that we see as an opportunity this year to improve our performance. It's addressing the opportunity we have to do better in working capital. Days inventory outstanding.

And certainly, the disruptions in the supply chain have contributed to some of the challenges there. We made some progress at the end of last year. We took down inventory even in a tough fourth quarter. We took down inventory and made progress in our supply chain there. There's more to do there. There's more opportunity there.

So that will -- that gives us a position to continue to drive even stronger cash flow, which gives us more flexibility in our capital allocation priorities.

Andrew Kaplowitz

Questions in the audience? Any questions? All right. Well, I still got 4 minutes. So maybe just can you update us on how much of your cash like ended up being spent in liabilities? I probably should know that number in '22, but like how much was it?

And then separately, can you update us on the time line? And you talked a little bit about Aearo Technologies. In terms of Combat Arms, PFAS litigation milestones. And then I just wanted to ask you one -- well, maybe I'll ask those 2, and then I'll ask 1 specific one after that.

Mike Roman

Well, I know Monish already has answered the first one once today. Are you going to answer it?

Monish Patolawala

Yes. So it's $900 million, is the amount of...

Andrew Kaplowitz

Okay. Good. And then like time line -- and I'll ask the other question here. So basically, Combat Arms will begin to be heard on May 1. I think the appeals for those, that's what I have in my notes. You tell me.

And thoughts on a reasonable time for the Seventh Circuit to rule on the Aearo bankruptcy case. Like -- and finally, like I'm getting little in the weeds, so forgive me. But why is the Seventh Circuit potentially different than the Third Circuit in terms of using the Texas 2-step rule?

Mike Roman

Yes. Maybe I'll start there just to differentiate it because there's a good level setting there, too. So what we have done with Aearo Technologies is not a Texas 2-step. It's -- Aearo Technologies is an existing independent business in 3M.

It really represents the business we acquired when we acquired Aearo Technologies in 2008. And so we -- they entered Chapter 11, and we have been supporting them in the mediation as part of that Chapter 11 process.

And the -- I would say the difference between Seventh and Third Circuit, there's a ruling in Third Circuit court on the J&J [LTL] case.

Andrew Kaplowitz

That's why I asked the question.

Mike Roman

There's still a lot of discussion about what the implications are of that ruling. So we are -- as we learn more about that, we'll update as we go. But we are -- right now, we are continuing to support Aearo in the mediation process, and that's our focus.

We have appeals pending on both the -- extending the state to 3M and in the Seventh Circuit and also the appeals in our original MDL bellwether cases. And we had some appeals related to that. So those are both pending and to come yet this year.

Andrew Kaplowitz

Got it. And PFAS later this summer is...

Mike Roman

PFAS is that next trials targeted and schedule is the MDL, the AFFF MDL, that in Federal Circuit Court in South Carolina, which is scheduled for June.

Andrew Kaplowitz

So let me ask you one more question, I've been asking all companies. So what are the top 2 or 3 innovations, megatrends or structural changes affecting your company over the next 5 years? And are there any emerging industry trends that are perhaps being overlooked?

Mike Roman

Well, I would frame it up this way, wherever there is a disruptive innovation in our customers is a tremendous opportunity for us in material science. And you see that in the answer to your question. And I've talked about a number of these already.

Automotive electrification is -- the electrification of transportation is a disruptive trend. And there's a lot of projections on how it's going to play out. It's -- a lot of innovation is going to come to bear on this. So we see opportunities. We see this as a growth opportunity.

We've been able to outgrow the build rate consistently of automotive build rates year-over-year by 300 to 500 basis points. The opportunities that come from that disruptive innovation enable us to continue to do that and continue to do that with our innovation and create value.

We see other areas that are exciting -- other areas, growth areas in electronics. We see -- electronics continues to be at the leading edge of material science innovation. And we participate in that, moving into those growth segments. We also are able to leverage that back into our company and into other areas and notably industrial kinds of applications.

I think areas like industrial automation is an [interesting] space. If you click down a little deeper, you look at something like film technology and electronics. And we've talked a lot about consumer electronics, build rates aren't growing as fast as they once did.

We talked a lot about our solutions into TVs, tablets, notebooks, mobile handheld. You look at the next-generation AR/VR/ER, the requirements on film technology goes to the next [1/1,000] of the structure in size. And so you're talking metamaterials. You're talking about flat optics for AR/VR, that really improve the performance and drive the viability and the effectiveness of those.

And those are some of the exciting areas where you're seeing disruption and our material science can play a role. And you see those in every one of our businesses health care, even as you prepare for the stand-alone company, biopharma processing, the material science opportunities there. Wound care management, material science opportunities there. Oral care and digital dentistry, the material science opportunities there.

They're all spaces that are disrupting and creating opportunities for new solutions, new penetration, even new businesses being built.

Andrew Kaplowitz

It sounds like a lot of opportunity. Well, we appreciate it. Mike, Monish. Thank you very much.

Mike Roman

All right. Thanks, Andy.