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3M Co
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Ladies and gentlemen, thank you for standing by. Welcome to the 3M First Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, April 26, 2022.
I would now like to turn the call over to Bruce Jermeland, Senior Vice President of Investor Relations at 3M.
Thank you and good morning, everyone and welcome to our first quarter earnings conference call. With me today are Mike Roman, 3M’s Chairman and Chief Executive Officer; Monish Patolawala, our Chief Financial and Transformation Officer; and John Banovetz, our Chief Technology Officer.
John is joining us today to discuss our progress on the sustainability goals that we introduced in February last year. Mike, Monash and John will make some formal comments, then we will take your questions. Please note that today's earnings release and slide presentation accompanying this call are posted on the homepage of our Investor Relations website at 3m.com.
Please turn to slide 2. Please take a moment to read the forward-looking statement. During today's conference call, we will be making 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 note, throughout today's presentation, we'll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments to today's press release.
Please turn to slide 3. Before I hand the call over to Mike, I would like to take a moment and highlight a financial reporting change we are making starting here in Q1 2022. We recognize that the increases in legal-related charges that we have incurred the past couple of years have impacted investors' understanding of our underlying financial and operating performance. We have been disclosing respirator and PFAS impacts in our public filings and have decided to provide additional disclosure by expanding the scope of our non-GAAP measurement adjustments to include all impacts of accrual changes and legal fees for respirator masks, PFAS and combat arms matters. This change is a result of discussions we have had with many of you, along with recent benchmarking work we have done.
This morning, we issued a Form 8-K with updated non-GAAP financial performance history for the past three years. Further, we will be issuing a Form 8-K amending our most recent annual report on Form 10-K to reflect the effects of this change in our non-GAAP measures and changes in segment reporting immediately after filing our Q1 2022 Form 10-Q this afternoon.
Also, our Q1 2022 financial performance and full year 2022 guidance in today's press release and presentation incorporate these changes.
Please note, that our guidance does not include future changes to reserves for PFAS or combat arms. Highlighted on this slide is the impact of this change to our non-GAAP financial reporting.
As you can see, operating margins in 2021 were 22.2% on this new adjusted basis, or up 70 basis points from pre-COVID levels in 2019, versus down 40 basis points on the previous basis. And adjusted EBITDA margins have expanded 110 basis points since 2019 to 27.6%.
Looking specifically at our Q1 2022 performance on slide 4, adjusted earnings were $2.65 per share. This result excludes total special items of $0.39 per share, which is comprised of $0.13 of legal related costs in the quarter, along with a $0.26 charge for PFAS-related remediation in Belgium, which we previously announced via a press release and Form 8-K filing on March 30.
As we indicated in the March press release and Form 8-K filing, this charge would be reflected as an adjustment in arriving at our first quarter results adjusted for special items. We remain committed to providing strong transparency in reporting our financial performance. And, of course, we are always here to address your questions.
With that, please turn to slide five, and I'll now hand the call off to Mike. Mike?
Thank you, Bruce. Good morning, everyone, and thank you for joining us. In a challenging global environment, 3M delivered a strong start to 2022. As Bruce just noted, to provide additional clarity on litigation-related costs and our underlying business performance, starting in the first quarter, we are reporting adjusted earnings to exclude significant litigation costs, which was $0.13 in Q1.
As we communicated on March 30, we also made an additional investment related to our operations in Zwijndrecht, Belgium, which resulted in a $0.26 charge. Excluding this investment, our financial outlook for 2022 remains unchanged.
As you recall, at our strategic outlook meeting in February, we committed to driving growth and shareholder value in 2022 by continuing to innovate for our customers and reposition our portfolio to win in attractive markets.
We also committed to deliver strong margins, EPS and cash flow through a focus on operational excellence, while continuing to invest in growth, productivity and sustainability. In the first quarter, we executed well and followed through on these commitments, which I will discuss on slide six.
We're relentlessly focused on serving our customers, while managing supply chain disruptions, inflation and geopolitical pressures. We posted organic growth of 2%, along with sequential margin improvement, adjusted EPS of $2.65 and robust cash generation.
Overall, demand is strong, though the global economic outlook has softened due to challenges in certain end markets, evolving impacts from COVID and recent geopolitical events.
All of our businesses started the year with good performance. End market demand was strong in Safety and Industrial, partially offset by a decline in disposable respirators.
In Transportation and Electronics, our automotive business continued to outperform build rates despite the impact of semiconductor shortages. Healthcare performed well with 5% growth and consumer grew 3% and in addition to 9% growth last year.
To position us for long-term growth, we continue to prioritize investments in high-growth opportunities across our businesses, commercial opportunities that are sizable and significant. For example, our automotive electrification platform grew 20% organically on the strength of new innovations on top of 30% growth in 2021.
In health care, our biopharma business posted 15% organic growth as 3M Science advances the development and manufacturing of new therapeutics and vaccines. To support growing demand for our biopharma solutions, we are investing $35 million to double capacity at our plant in Columbia, Missouri.
We also continue to manage our portfolio and unlock value for our customers and shareholders. We are on track to close the divestiture of our food safety business in the third quarter. And in March, we divested our floor products business in Western Europe, enabling us to prioritize other parts of our consumer business.
In addition, yesterday, we announced that we acquired the technology assets of LeanTec a provider of digital inventory management solutions for the automotive aftermarket segment in the United States and Canada. It is another example of how we win in the core and build for the future, creating new platforms to access emerging trends and opportunities.
In this case, the connected bodyshop, one of 3M's digital platforms that brings together data, analytics and material science. We continue to navigate global supply chain disruptions, which have been amplified by recent geopolitical unrest.
We are doing whatever is necessary to take care of customers, while managing extended lead-times and elevated inventory levels. At the same time, we have continued to drive strong pricing to offset inflation.
Like many other global companies, we are actively managing through the conflict in Ukraine. Our focus remains on ensuring the safety of 3Mers in harm's way. I am proud how 3M has stepped up to help from donating nearly $4 million to employees welcoming refugees into their homes. We stand with our Ukrainian colleagues and have suspended operations in Russia.
Given what we are seeing around the world, we expect supply chain challenges to persist for the foreseeable future. Our balance sheet remains strong, allowing us to invest in the business while returning $1.6 billion in the quarter to our shareholders through both dividends and share repurchases. We increased our dividend in the first quarter, marking our 64th consecutive year of increases.
With respect to litigation, we are vigorously defending ourselves in combat arms bellwether cases. We are pleased that a jury cited with 3M in the most recent bellwether trial earlier this month, which was a plaintiff's counsel pick.
To-date, we have won six and lost eight trials and have appealed or will appeal all adverse verdicts. Eight bellwethers were also dismissed by plaintiffs before they went to trial.
I would also like to provide an update on operational disruptions at our factory in Zwijndrecht, which I know is top of mind. Last month, I visited Belgium to meet with local leaders and affirm our commitment to the Zwijndrecht community. As previously stated, we continue to work with Flemish authorities to address our remediation obligations and work toward greater operational certainty.
Last September, we announced an investment of €125 million to advance air and water stewardship in our existing operations, which has included the installation of a new state-of-the-art filtration system. In addition, last month, we committed €150 million to remediation that addresses legacy manufacturing and disposal of PFAS on 3M site and in the surrounding area.
To help reduce the impact to customers, we are supplying from other global sites and actively working to address any future potential impacts. We will continue to collaborate with officials to bring idle processes back online in Zwijndrecht, deliver essential products to our customers and follow through on our commitments.
On May 11, we will publish our Global Impact Report, highlighting our progress to our sustainability commitments. In a moment, 3M's Chief Technology Officer, John Banovetz, will provide an update on an important part of these commitments, our environmental stewardship goals.
In summary, the first quarter was a good start to the year for 3M, and I thank all of our employees for their contributions. As I mentioned earlier, we are committed to addressing the broader challenges of supply chain disruption and litigation risk as we continue to invest in our underlying businesses, which remain strong and well positioned to grow.
We are maintaining our full year expectations as adjusted for the reporting change that we have discussed, which will provide greater clarity regarding our underlying performance as we navigate litigation matters. At 3M, we are driven by purpose and powered by four industry-leading businesses, unique global capabilities and a highly experienced and diverse team. I am confident in our ability to grow above the macro and improve our operational performance as we move through 2022.
I will now turn it over to John Banovetz. John?
Thank you, Mike. And please turn to slide 7. As a global manufacturer, 3M has a long record of environmental stewardship. Over the last two decades, we have reduced our greenhouse gas emissions by 75%, while more than doubling our revenue. Nearly 50% of our global electricity use is renewable, on our way to 100%. And over the last five years, our innovations have helped customers avoid 100 million tons of emissions.
To drive our growth as a company, we will continue to build on our strong foundation, advance our strategy and invest in science-based commitments to improve the environment. Last year, we accelerated our leadership with a commitment to invest $1 billion and deliver our new goals around air, water and waste.
As you see on the left side of the slide, our goals are meaningful, authentic and impactful to the world. They are rooted in 3M science, applying math to a path to rapidly bend the curve on emissions. We committed to a 10% reduction in water use by 2022 and a 25% reduction by 2030.
To improve water quality, we committed to install filtration technology by 2023 at our largest water using sites, and we committed to become carbon neutral with aggressive milestones along the way.
Finally, we will reduce our use of virgin fossil-based plastic by 125 million pounds by 2025. Over the last year, we have made strong progress on each of our goals, putting us ahead of schedule in some areas and on track in all other areas. We have already cut our carbon footprint by 25% and reduced our use of water by more than 10%, which included a new closed-loop water recirculation system at our factory indicator, Alabama.
As Mike mentioned, we've also advanced our filtration capabilities in Zwijndrecht with a new state-of-the-art system. Part of the €125 million investment we announced last September with additional work completed at several other 3M sites.
Later this year, in Cordova, Illinois, for example, new filtration technologies will be fully installed, including ion exchange and reverse osmosis. We've announced $165 million investment in Cottage Grove, Minnesota, which follows our decision last year to close our incinerator, resulting in improved waste management while reducing energy and water usage at the site.
In addition, over the last year, we have reduced our use of plastic by 19 million pounds through innovative designs in our consumer business, such as our Scotch double-sided mounting tape, which we reformulated to eliminate PVC plastic and packaging and reduce our solvent use by 300,000 pounds per year.
In summary, we are on track to meet or exceed each of the goals laid out last February, and we will advance our progress in 2022. This year, we expect to reduce our water usage by an additional 5%, double our reduction of virgin-based plastic and further expand our filtration capabilities across our largest water using sites.
I'm proud of how 3Mers have come together to follow through on our commitments. Moving forward, we will continue to work with communities, customers and governments to advance our environmental stewardship and make a difference in the world. As Mike mentioned, I encourage you to read our annual global impact report to be released on May 11 with more details on our priorities and progress.
Now, I will turn it to Monish, who will cover the details of the quarter. Monish?
Thank you, John. And I wish you all a very good morning. Please turn to slide nine. The 3M team delivered strong execution in Q1 in a macro environment that remains extremely fluid and increasingly uncertain. We remained focused on delivering for our customers, drove operational execution and maintained cost discipline, while also continuing to invest in the business to fuel growth.
First quarter total sales were $8.8 billion, which increased 1.7% on an organic basis. As a reminder, organic sales growth does not include impacts from FX or M&A. Adjusted operating income was $1.9 billion, with adjusted operating margins of 21.4% and adjusted earnings per share of $2.65.
On this slide, you can see the components that impacted our operating margins and earnings per share performance as compared to Q1 last year. We continue to drive price actions, realize savings from past restructuring and maintain strong spending discipline, which helped offset both known and new headwinds.
As I highlighted in my February Investor Day presentation, we made significant progress driving actions in 2021 to address rising raw material and logistics costs. We are leveraging the power of daily management, data and data analytics, along with the spirit of embracing the red to direct actions to offset the inflationary pressures.
During last year, we developed new sourcing and pricing tools and processes to improve agility, drive alignment and simplify our processes. In addition, we are also enhancing our reporting and data analytics capabilities by rolling out tools that model price realization, leakage and elasticity.
These efforts continue to pay off in Q1 as benefits from selling price actions offset raw material and logistics headwinds.
Looking ahead, while we see raw material and logistics inflation persisting, we will continue to leverage daily management powered by data and data analytics with the expectation of offsetting raw material and logistics inflation through pricing actions in 2022.
Also, during the first quarter, we completed the final actions related to our December 2020 restructuring announcement. Since Q4 2020, we have incurred total pretax restructuring charges of approximately $280 million versus an original expectation of $250 million to $300 million.
These actions are expected to deliver total pretax savings of approximately $250 million are at the top end of our estimated range of $200 million to $250 million. We realized $180 million of the savings in 2021 and expect the balance of the savings of $70 million in 2022, which is incorporated in our guidance.
In the quarter, we experienced a year-on-year decline in disposable respirator demand of nearly $50 million, which negatively impacted operating margins by 10 basis points and earnings by $0.03 a share.
On any given day, our global sourcing, manufacturing, and supply chain teams continue to navigate a number of items, including raw material and logistics availability, evolving COVID-related impacts, including mandated lockdowns, employee absenteeism in our US factories in January and February, and now in China, the continued shutdown of certain operations in our plant in Belgium, and recently, the impacts on the geopolitical crisis in the Ukraine. These dynamics continue to result in ongoing changes to demand plans, along with increasing costs and pressuring manufacturing productivity as we work to serve our customers.
Also, as you will hear from me throughout the year, we continue to prioritize investments in growth, productivity, and sustainability to drive long-term performance and capitalize on trends in large, attractive markets, including automotive, home improvement, safety, health care, electronics, and software.
Moving to raw materials, we continue to experience inflationary pressures with a year-on-year increase of approximately $215 million in the quarter, which resulted in a headwind of 2.4 percentage points to margins and $0.30 per share to earnings.
Foreign exchange fluctuation is something we are watching closely, particularly given the geopolitical uncertainties. During the quarter, FX was a benefit of 10 basis points to margins, however, was a negative $0.04 per share impact to earnings year-on-year, primarily the result of the strength of the US dollar.
Other financial items increased earnings by a net $0.04 per share year-on-year with benefits from a lower share count and a decline in net interest expense, more than offsetting a headwind from a higher tax rate.
While year-on-year margins and earnings declined, it is also important to look sequentially given the fluid and uncertain environment. Our actions to continue to drive price to offset inflation, navigate supply chain challenges and control costs enabled us to expand adjusted margins and earnings 140 basis points and $0.20 per share, respectively.
Please turn to slide 10. First quarter adjusted free cash flow was $715 million, with conversion of 47%, which was in line with our expectations. Year-on-year conversion was lower due to higher cash compensation and an increase in CapEx for growth and sustainability investments.
Looking at the full year, our free cash flow conversion expectations of 90% to 100% remain unchanged. As you know, we currently have a very fluid environment, especially around global supply chain and logistic challenges. Therefore, we will experience some working capital ups and downs in the short run, but you should see the benefits of the power of data and analytics and operational rigor start to play out once things stabilize.
Capital expenditures were $424 million in the quarter, up 37% year-on-year as we increase investments in growth, productivity and sustainability. For the full year, we continue to expect CapEx to be in the range of $1.7 billion to $2 billion. During the quarter, we returned $1.6 billion to shareholders through the combination of cash dividends of $852 million and share repurchases of $773 million.
Our cash flow the global economic situation and our stock price are all factors into determining the pace and amount of share repurchases. We believe our current stock price presents a good buying opportunity and we have been active in the market to start the year. While we are currently out of the market due to the pending food safety divestiture, we currently anticipate $2 billion in aggregate share repurchases over the course of the full year.
Net debt stands at $13.3 billion, up approximately 2% as we continue to invest in the business. Our capital structure is well positioned, giving us financial flexibility and optionality. Our strong balance sheet and cash flow generation capability, along with disciplined capital allocation continues to provide us the financial flexibility to invest in our business, pursue strategic opportunities and return cash to shareholders while maintaining a strong capital structure.
Please turn to slide 12 for our business group performance for Q1. I will start with our Safety and Industrial business, which posted organic growth of 0.5% year-on-year in the first quarter. This result included a disposable respirator sales decline of approximately $50 million year-on-year, which negatively impacted Safety and Industrial's Q1 organic growth by 1.5 percentage points. Our Personal Safety business declined mid-single digits organically versus last year's 20% pandemic-driven comparison.
Looking ahead, we continue to anticipate that COVID-related disposable respirator demand will decline as we move through 2022. However, if trends change, we remain prepared to respond to changes in demand as COVID impacts evolve.
Turning to the rest of Safety and Industrial. Industrial adhesives and tapes electrical markets, abrasives and closure and masking were all up mid-single digits compared to last year, while roofing granules and automotive aftermarket businesses were up low single digits.
Safety and Industrial's first quarter adjusted operating income was $699 million, down 14% versus last year. Adjusted operating margins were 22.9%, down 3.5 percentage points.
Year-on-year, adjusted operating margin performance was impacted by higher raw materials and logistics costs and manufacturing productivity headwind. Partially offsetting these impacts were selling price increases, spending discipline and benefits from restructuring actions.
The Safety and Industrial business group continues to focus on building the future through emerging trends and opportunities. Most recently, 3M acquired the technology assets of LeanTec to advance digital solutions for auto body shops.
This digital platform integrates data capture and analysis with material product platforms, providing shop owners and managers more access to data for enhanced productivity and inventory management.
Moving to Transportation and Electronics on slide 13, which declined 0.3% on an organic basis, primarily due to the ongoing impact of semiconductor supply chain constraints on the automotive and consumer electronics end markets.
Organic sales in our auto OEM business were flat year-on-year, versus a 5% decline in global car and light truck builds, as we continue to gain penetration on automotive platforms.
Our electronics-related business declined low single digits organically, with declines across consumer electronics, particularly smartphones and TVs. These declines were partially offset by continued strong demand for our products and solutions in semiconductor and factory automation end markets.
Turning to the rest of Transportation and Electronics. Commercial Solutions grew high single digits. Advanced Materials was flat, while transportation safety was down mid-single digits year-on-year.
First quarter operating income was $496 million, down 11% year-on-year. Operating margins were 21.2%, down 2 percentage points year-on-year. Operating margins were impacted by higher raw materials and logistics costs, manufacturing productivity impacts and investments in auto electrification. These year-on-year headwinds were partially offset by increases in selling price, strong spending discipline and benefits from restructuring actions.
The Transportation and Electronics business group is focused on executing well against its strategic imperatives to build new growth platforms in high-growth segments, including automotive electrification, semiconductor, electronic materials and graphic and architectural films.
Turning to our health care business on slide 14, which posted a first quarter organic sales increase of 4.7%, with growth across every business. Our Medical Solutions business increased mid-single digits organically. First quarter US elective medical procedure volumes were approximately 85% to 90% of pre-COVID levels, as COVID slowed the pace of procedures, particularly in January and February.
Sales in our Oral Care business grew low single digits year-on-year. Global oral care procedure volumes dipped in January and February due to COVID, but started to recover in March. Overall, patient visits for the quarter were 85% to 90% of pre-pandemic levels.
We continue to watch COVID-related trends and its impacts on the global healthcare industry, including labor shortages, which drove lower-than-expected surgical and dental procedure volumes in the quarter.
The separation and purification business increased mid-single-digits year-on-year with sustained demand for biopharma filtration solutions for COVID-related vaccines and therapeutics. Health Information Systems grew mid-single-digits, driven by strong growth in revenue cycle management and clinician solutions.
And finally, food safety increased high single-digits. As Mike mentioned, we remain on track for a Q3 close of the planned divestiture of this business, which will be combined with Neogen.
Healthcare's first quarter operating income was $448 million down 3.5% year-on-year. Operating margins were 21.1%, down 1.4 percentage points. Year-on-year operating margins were impacted by raw materials and logistics costs, manufacturing productivity, investments in the business, and food safety deal-related costs. These impacts were partially offset by benefit from leverage on sales growth, strong spending discipline, and benefits from restructuring actions.
Despite the current environment, the Healthcare business group is focused on delivering clinically differentiated innovative platforms that improve patient outcomes and reduce cost of care.
We have been sharply focused on three key segments; wound care; health care IT; and biopharma filtration. These segments are well supported by key market trends, which include; increasing chronic conditions driven by an aging population; shifting of care to lowest cost setting; improving health care access trends; and finally, digital and connected solutions.
Please turn to slide 15. Lastly, our Consumer business delivered first quarter organic growth of 3.4% versus last year, with growth across every business. Our Home Improvement business continued to perform well, up low single-digits on top of last year's growth of over 20%. This business continued to deliver strong growth with our home improvement retail customers in our category-leading Filtrete and Command brands.
Stationery and Office and Home Care grew low single-digits organically in Q1. And finally, our Consumer Health and Safety business was up low teens year-on-year.
Consumer's operating income was $224 million, down 17% compared to last year. Operating margin was 17.1%, down 3.7 percentage points year-on-year. Historically, Q1 is typically our lowest margin quarter of the year for our consumer business. But this year's operating margin was further impacted by ongoing supply chain constraints, along with higher raw materials and outsourced hard goods manufacturing costs and manufacturing productivity impacts. These headwinds were partially offset by good price performance, strong spending discipline, and benefits from restructuring actions.
Continuing to innovate and drive sustainability within the Consumer Business Group is a top priority. As consumers and businesses are increasingly shopping online, they want solutions that protect their packages and content, while making the process more convenient and sustainable than ever. As a result, we recently launched Scotch Cushion Lock, a new sustainable alternative to plastic cushion wrap and a perfect solution for protecting and packaging items with 100% recycled paper. Our Scotch portfolio is centered on innovating and serving this large and growing market.
Please turn to slide 17 for a discussion on our 2022 outlook. As you know, most companies are facing a macro environment that has become even more fluid and uncertain due to several factors, including continued global supply chain and logistics challenges, ongoing impact from semiconductor constraints, particularly on the automotive and electronics industries, evolving impacts of COVID-19, growing geopolitical uncertainties, increasing foreign exchange volatility and finally, rising inflationary pressures, including raw materials, logistics, labor and energy costs. This has resulted in softening trends impacting full year growth expectations for GDP and IPI.
Both macro indices are now expected to be up approximately 3% versus up 4% at the start of the year. Despite the fluid and uncertain macro environment, we continue to expect organic growth in the range of 2% to 5%. Adjusted earnings per share is expected to be $10.75 to $11.25. This range incorporates the change to our adjusted earnings that Bruce highlighted at the start of the call. And finally, free cash flow conversion expectations remain in the range of 90% to 100%.
Before I wrap up, let me make a few comments regarding the second quarter. First, we are seeing a slow start to sales in April, primarily due to COVID-related impacts in China, along with the geopolitical crisis in the Ukraine. Raw materials and logistics costs are expected to be up, impacting Q2 year-on-year by approximately $225 million. We expect disposable respirator demand to decline both year-on-year and sequentially by approximately $100 million to $200 million.
During the first quarter and particularly over the last month, growth expectations for transportation and electronic end markets have moderated. Second quarter global auto builds are currently forecasted to increase approximately 2% year-on-year, however, declined 3% sequentially. And smartphones are forecasted to be up approximately 1% year-on-year, but declined 5% sequentially. We expect both US medical and oral care elective procedure volumes in Q2 in the range of 90% to 95% of pre-COVID levels.
And finally, as a reminder, last year's second quarter included an approximately $90 million operating income benefit or $0.12 per share from a Brazilian Supreme Court social tax ruling.
To wrap-up, although we remain cautious in this current environment, we are bullish about the long term. We are committed to delivering for our customers, taking appropriate price actions driving operational execution and managing spending, while continuing strong financial rigor and maintaining a strong capital structure and financial flexibility.
In the long run, we will grow about the macro, expand margins and deliver strong cash. I want to take a minute to thank the 3M employees for delivering for our customers and shareholders in a very uncertain and fluid environment. Our team delivered 1.7% organic sales growth in the quarter, 21.4% adjusted margin, up 140 basis points sequentially and generated $715 million in adjusted free cash flow.
I also want to take a moment to personally thank our customers and suppliers for putting their trust and confidence in us and for maintaining strong and close partnership that help us navigate the current challenges. We had a good start to the year. We are watching the environment closely and working on navigating current challenges, with more work to do. That concludes my remarks for the first quarter.
With that, we will now take your questions.
[Operator Instructions] Our first question comes from Steve Tusa with JPMorgan Securities. You may proceed with your question.
Hey, guys. Good morning.
Good morning, Steve.
Good morning, Steve.
Can you just maybe give a little more precision on the second quarter? And then, I mean, there's a lot of kind of moderate downward revisions to some of the assumptions. I'm just not 100% clear to me how the guide is reaffirmed, maybe you're talking about more -- you're still within the range but towards the low end? Just kind of those two factors, just to start.
Sure, Steve. I'll just start with the overall guide for the year. As you know, we don't give quarterly guidance. So the guide for the year, coming into the year was 2% to 5% organic growth. We are continuing to see that, that that's doable in the 2% to the 5% growth, no change there at all.
The purpose of giving you the second quarter outlook was just, as you're building your models to help you think through the macroeconomic environment. As I've said, the start to April was slower, mainly driven by China and the work there. But we'll have to see when the lockdowns are released and how fast China ramps up historically when they have the ramp-up is there. So we're just giving you what we've seen in April.
And then, you can see some of the macro trends in the auto and consumer industry have gone down sequentially, driven by semiconductor and chip shortages, but health care starts moving up from the 85% to the 90% to the 90% to the 95%. So puts and takes for the year, we still see ourselves getting to the 2% to the 5% range that we told you about with adjusted earnings per share of $10.75 to $11.25. So no change there.
Overall, I would say -- and market demand has remained strong in the first quarter. So far, we are seeing it strong, other than for what I told you about China, but we are overall still seeing markets strong. And I think time will play itself out on how some of these uncertainties go through the year, but bullish about the long term and bullish about the year.
Got it. Great. Thanks a lot.
Yes. Thanks, Steve.
Our next question comes from Scott Davis with Melius Research. You may proceed with your question.
Good. Thank you. Good morning, everyone.
Good morning.
Good morning, Scott.
I think a lot of the issues you addressed this morning are pretty comparable to what we've seen everywhere else. But can we talk a little bit about pricing? I know you stopped breaking that out as a line item, but perhaps, you can talk more big picture.
I mean, last quarter, you were up 2.6% price and your core volumes this quarter, around 2%, so that would imply you probably -- if I had to guess, you probably a little bit better than that in price and maybe volumes are more flattish on apples-to-apples.
But can you talk about kind of the price cost parity goals? I mean when do you think -- given the higher costs that have come in even just in the last month, when do you think you can reach your price cost parity -- can you reach it this year and perhaps when? And directionally, our price is still going up. And I'll pass it on after that. Thank you.
Sure, Scott. Listen, the team did an amazing job. As I've talked about the tools that we've had, the daily management. Last year, we started slow on pricing, 0.14%, went up to 1.4% in Q3 and 2.6% and in Q4. This quarter, we continued the momentum, which was driven by two pieces, the carryover impact, plus new pricing.
As I said in my prepared remarks, we more than offset the amount of inflation. So, if you just do the math on a rate basis, not just on a dollar basis. So, that's -- we got a 3% plus price in the quarter. The team is very focused on looking at the extra inflation that's coming in, they're already working on higher price. And as I said in my prepared remarks, the goal is to offset the extra inflation that we are seeing with extra price and so a really good start to the first quarter.
Okay. Thank you.
Our next question comes from Nigel Coe with Wolfe Research. You may proceed with your question.
Nigel, are you there?
Mr. Coe, your line is open. You may proceed with your question.
Operator, why don't we move to the next question please?
We will move on to the next one from Julian Mitchell with Barclays. You may proceed with your question.
Hi, good morning.
Good morning.
Good morning. Maybe just a first question around the -- I understood on the Belgian plant, the remediation measures. But it is a topic that you sort of mentioned a bunch of times in recent months, and we get that question a lot on the plant from investors. Just trying to scale sort of the import of the plant to 3M's kind of aggregate operations.
Maybe help us understand kind of what impact from the plant production issues is dialed into your guidance now, now that you're sort of giving us a full update with one quarter behind you. Where are we in terms of kind of inventories at that plant that you can keep shipping from it even without full production?
Yes, Julian. So, as we've talked in the past, we've had some certain operations shut down at that plant, and we continue to work on -- with local authorities on the updated permits that we have there and continue to work to resolve that.
We're a leading provider out of that plant for specialty fluids, including heat transfer fluids that are used in semiconductor, and we're working to address the operational disruptions we have. Zwijndrecht is an important source of supply for those materials to our customers. And so we're working to resolve it there, so we can continue to supply from there. We're also looking to supply from capacity that we have at alternative sites where possible. So it's it was an impact that we saw in Q1. It's something that's built into our outlook. It is something we're working with customers on to address any ongoing disruption for them. So it's something we'll keep updating you on as we mitigate the impacts and we can update you as appropriate going forward.
Understood. But it's not a sort of material headwind dialed in for Q2 or the balance of the year. You can sort of cope with it, the shortage still.
Yeah. There is a process we're working through. And so there's some uncertainty there. We've got to resolve the permit issues there. We've got a permit renewal as we go through the year. So this is all something that we're working on. We've been careful to say that we have certain operations that have been interrupted at this time. There's a potential for operations to resume. There's a potential for operation – additional operations to shut down. So we've been careful to lay out the possibilities. What we saw in – in Q1 was part of our results and is an interruption that we're working on with customers.
That's helpful. And then just my follow-up around the EMEA region, you saw organic sales down about 2% there in the first quarter, understood that probably April is maybe trending worse than that based on Monish's comments. Maybe help us understand kind of are you seeing in EMEA exactly? Most companies seem to say it's about the same as it was a few months ago. Your sort of numbers and comments imply that you are seeing some kind of shorter cycle weakness there. So maybe help us understand kind of what's changing in Europe by region or industry in terms of demand for you?
Yeah. And Julian, as you recall, we realigned around our businesses back in March of 2019. So we really are managing each of our four go-to-market models globally and executing in the areas. We update you on just how we're performing overall in the areas of the world. And so EMEA down 2% in Q1 really was led by declines in our Consumer and Safety and Industrial businesses.
Transportation and Electronics was down slightly. Health care was up actually low single digits in the quarter. So we saw some impact from both, I would say, COVID as well as the supply chain disruptions and the – I would say, the challenges in Ukraine. So it's a – it is an ongoing dynamic that we're watching closely. We saw strong growth in a number of our businesses as we came through the quarter and Monish walked through the outlook on the macro. So certainly, that will have an impact on EMEA. But I would say we're watching it closely as we look at the rest of the year.
Great. Thank you.
Our next question comes from Jeff Sprague with Vertical Research Partners. You may proceed with your question.
Hey. Thank you. Good morning, everyone.
Hi, Jeff.
Good morning, Jeff.
Hey, good morning. Just thinking about the adjusted framework, and I didn't get a chance to go back and look at all the restatements. But just to be clear, -- so on a move-forward basis, we're just excluding litigation and environmental-related costs, both on the go forward and on the way you restated the numbers?
I'm not sure I follow, Jeff, but you're asking, are we going to a go-forward basis? Yes. So we have made the adjustment that going forward, all costs for significant litigation matters will be shown as an adjustment to our earnings. And so you will see the GAAP EPS number, which is reported and adjusted earnings per share.
And we have also filed an 8-K showing you restating the history. And just so that you can catch up on what it was, and Bruce talked about in his prepared remarks is, for example, in 2021, we would have excluded approximately $0.61, which was cost for significant litigation matters as a -- to show it as an adjustment, which will be 140 basis points of margin impact.
Yes, Jeff, the other comment I would have is, it does not include potential changes in future reserves, just so that's clear.
Yes. I mean the thing that's tricky about this guide, it's not to editorialize, right, but I think you're leaving things like Brazil charges and gains that are truly one-off in the numbers. And stuff like litigation that might be lumpy, but is sort of ongoing and pulling that out of the numbers. I mean, I guess, we all have the discretion to use GAAP if we want. But it's just a confusing construct, I think, to use.
Fair point, Jeff. Fair point. At the end, listen, the first results are GAAP EPS. There's no going away from that. The reason we have broken this out into TWO was, there was a lot of requests from investors asking us to show -- to bring better clarity to the underlying performance of our business.
And we have disclosed $90 million. We disclosed that last year, too. We are disclosing it this year, too, as a reminder of what we disclosed last year. And there was an ask for people to know how much we were spending on cost for our litigation-related matters. So we've shown that as a separate line item.
You can put it either way. At the end of the day, GAAP EPS is the first thing. Second is the adjustment. So you can see how much you're spending on litigation and you can see the -- bring clarity to our underlying business. So, hopefully, that clarifies.
YES. Thank you. And then just on the kind of the litigation milestones. Can you update us on what is next on the docket, I believe, there's a few more things on combat arms. Maybe there's some other things we should be aware of, as we're looking over the balance of the year.
Yes. So Jeff, we still have two combat arms, bellwether cases to go here in May. So those are the next the next two trials on the docket. Beyond that, it's a little less clear what the next cases will be.
If you look at PFAS, the other one trial schedules, I would say, have been moving frequently. We we're currently scheduled for two trials this year. We have a June trial in Michigan, and then we have an October trial in Alabama. The Aqueous Film Forming Foam multi-district litigation, the first trial there is not expected until 2023. So that gives you kind of an update.
Great. Thank you.
Yes.
Our next question comes from Andy Kaplowitz from Citi. You may proceed with your question.
Good morning, everyone.
Hi, Andy.
Hi, Andy.
Monish, to the extent you can, could you give us a little more color on how you're thinking about Safety and Industrial margin moving forward? I know margin was down year-over-year, but it was materially up sequentially versus the last couple of quarters.
Is that a function of maybe better mix with mask being a bit stronger? I think you mentioned strong spending discipline restructuring to the extra $70 million restructuring benefits find their way into the segment in the quarter in a bigger way?
Yes. So, I would tell you, I'll start, Andy, with -- if you go back to Mike Vale’s comments at Investor Day, he talked about one of his priorities is continuing to drive margin expansion. And we saw that sequentially. We knew going into the year that the year-on-year comp will be difficult, as you correctly pointed out with the amount of inflation. But the team has driven momentum on all items, which is price, continue to see the restructuring benefits, we're able to continue to drive productivity in the factories, at the same time, continue to invest in the right amount of growth as based on the priority platforms that we have listed out, and you saw it in the first quarter.
Our mask respirator did come in better. When we had come in in the beginning of the quarter, we had told you it would be down sequentially. $100 million to $150 million. It came in at $50 million down, so we know we came in stronger. I think we'll have to watch what the year plays out when it comes to mask respirator and see where that lands is.
We've also told you -- it does have an impact on us on an incremental margin basis. And coming into the year, we had said it to be down 700 on a year-over-year basis. But to sum it up, Mike, Wale, and his team are focused on continuing to drive margin expansion as all the initiatives that they've taken from productivity, price, restructuring continue to play out; offset that and as stability comes in, you'll start seeing the productivity also starting to kick in from a margin perspective. So, a good start to the year.
That's helpful. And I just want to follow up on Jeff's question just to make sure I understand the ongoing litigation costs. It looks like ex the special charge to the Belgium facility that you're guiding to about $0.35 of special items for 2022, but your litigation expenses have been running at like $0.13, $0.14 a quarter. So, are you expecting litigation cost to ramp down as the year goes on? Are there gains you're expecting? Any more color there, am I understanding it right?
Yes, Andy, this is Bruce. If you look at our press release attachments, we lay out about $600 million in pretax charges estimated for the year. That includes the Zwijndrecht charge that we took in Q1. So, setting that aside, underlying ongoing litigation cost to be about $450 million.
From a total EPS impact for the year, we forecast $0.86, which includes $0.26 related to Zwijndrecht charge in Q1. So, yes, the remaining $0.60, we took roughly $0.13 here in Q1.
Thank you.
Yes.
Our next question comes from Joe Ritchie with Goldman Sachs. You may proceed with your question.
Thanks. Good morning guys.
Hi Joe.
Hey. Bruce, I just wanted to follow up on the $600 million. I'm just curious, like, what does that actually encompass in terms of litigation? And then also, is that all cash?
Yes. So, when we provided our guidance back in February, encompassed in the $10.15 to $10.65 was a plan of about $0.60 on of costs related to ongoing litigation matters around PFAS, combat arms, and respirator. So -- and then we had an additional $0.26 charge as we announced on March 30th. So that what brings it to a total of $0.86.
Relative to cash, Joe, that's difficult to know exactly when that plays out. For example, the $0.26 charge we took here in Q1 will be paid out over time as remediation actions take place. But also, it's important to remember that there is no presumed forecast relative to updates to reserves. So largely, we'll be cash driven, but won't line up 100%.
Got it. That's helpful. And then really, just wanted to follow up on China, I saw that it was down low-single digits in the quarter. I'd be curious, Mike or Monish, maybe just provide how that was trending as the quarter ended and into April. And then also, if you could provide a little bit of end market color, I would imagine that respirator sales are probably holding up a little bit better. But any type of commentary you can provide on trends there by end market would be helpful.
Yeah. Sure, Joe. I'll start with what you said it were down low-single digits in the first quarter that was reminder a top of 30% or more than 30% growth in Q1 of last year. We’ve been impacted in Q1 by the COVID lockdowns. It's impacting manufacturing and distribution. And we saw that as we finished the quarter – it's also contributing to, I would say, a soft start to April as well. And it's really driving increasing backlog, factory shutdowns for us, also complying with government safety mandates, you're seeing increased port congestion, reduced air cargo capacity.
So a number of things impacting that softer start. I would say it's – the outlook remains uncertain. It's difficult to predict. We see maybe a one percentage point kind of headwind as we start Q2, but that can change as we go through the year. So it's – it's important market we're seeing in Q1, we saw health care leading the way up mid-teens. We saw declines across consumer, safety, industrial and transportation and electronics, all down mid-single digits. So that's what got you to the low single digits.
Helpful. Thank you.
Our next question comes from Andrew Obin with Bank of America. You may proceed with your question.
Thanks. Good morning.
Hi, Andrew.
Hey, Andrew.
Just a question on the consumer business. Historically, looking at your consumer peers gives you a fairly good indication where you guys can come out, but sort of looking at where Avery is, Kimberly, I think Procter & Gamble have reported. Your numbers seem to be this quarter, quite a bit below the peer group. And also, in particular, if you look at some of the verticals that you disclosed like roofing granules, home improvement, separation purification, I would have expected those to do better given the end market? I guess the question I'm asking, we know the issue in the Belgium facility, but should we be thinking about a specific vertical within your technology portfolio that's being particularly impacted by supply chain that sort of gauge your ability to grow in this environment?
Yeah, Andrew, I would say you highlighted a couple of those particular challenges. The supply chain more broadly is impacting all of our businesses. So we're seeing disruptions in raw materials, logistics, inflation all that's impacting broadly our portfolio. Consumer did have organic growth up 3% in Q1 on top of 9% last year. And it was across all divisions. It was led by consumer health and safety also our home care and our home improvement products continue to lead the way. So we're seeing growth. And stacked on top of last year's growth, we're seeing good continued performance, good performance.
They're not seeing any specific or particular impact. And if you look across the portfolio, aside from some of the disruptions from Zwijndrecht, we're not seeing supply chain focused in one part of our portfolio and other.
It is, I would say, more -- some of the impacts maybe from COVID having a geographic impact. Health care elective procedures still looking for there. And as Monish highlighted, the outlook for the macro in certain end markets is softening. That's less about supply chain disruptions.
Maybe automotive and electronics being impacted by semiconductor shortages but its really more end market slowdowns that are impacting our businesses, where you see an impact on something like electronics or automotive.
Got you. And just a follow-up question. Interesting to note that you guys continue to push into electronics. You highlighted it as one of your sort of technologies within your periodic table. Can you just talk more about sort of potential M&A opportunities when it comes to digital and how do sort of see it fitting into your broader portfolio? Thanks.
Yes, Andrew, our M&A strategy, an important part of capital allocation. We see it as a place we can create value. And the way we create value there is, as you're pointing at, we look at prioritizing attractive markets, higher growth markets that can leverage 3M capabilities, our technology, our manufacturing, our global reach to customers.
And so, that really kind of steers us in our strategy for M&A. And when we can identify companies that we can integrate into 3M and really leverage those strengths of 3M, that's -- and move into more attractive, higher-growth market spaces, that's what's going to drive us, whether it's in opportunities around electronics or any one of our four businesses.
Thank you.
Our next question comes from Brendan Luecke with Bernstein. You may proceed with your question.
Good morning, guys. Thanks for taking my question.
Hey, Brendan.
Good morning, Brendan.
So, just, I wanted to circle back on a couple of items from the guidance call earlier this year. Wondering how point of view may have changed given ongoing pressures on the business. So first off, I believe you talked about from 30% incremental net of respirator impact? Is that still a target in light of continued inflationary headwinds?
And then, second part would be around operating cash flows. You guys have guided to, I think, $7 billion to $8 billion, but we came in around $1 billion in Q1. Wondering sort of what the puts and takes look like to get to the FY target there.
Yes. So I'll start with your operating leverage question, Brendan. What I've said is, always in the long term, 30% to 40% is what our targeted leverage is, incremental leverage. And when you just think about it and look at our gross margin, which is anywhere between 45% to 50%, you can see you can get to the 30% to 40%.
On top of that, what I would tell you, volume gives us the best leverage, so the more we can grow, you're going to get more incremental leverage. Add to that productivity in the factory, strategic sourcing will add more to that leverage and then continued actions to drive simplification, et cetera, all of them drive positive leverage.
Then to that, we take some of that and we invest it back into growth, productivity and sustainability and then, of course, manage the litigation matters, et cetera, is ongoing. So when you put all that together, long term 30% to 40% is what is doable.
When we came into the guide for the year, we had said its 30% to 40% is our target. We said around 30%. If you look at the midpoint of the range right now, which we have given you, which is 2% to 5% revenue growth, $10.75 to $11.25 on an EPS basis, and you put in FX, which could range anywhere from 1% to 2%, we ended at 2% right now for the first quarter and you assume that carries over, you will see that we are still targeting at the 30%.
We are seeing higher inflation as everyone is seeing, but as I've said in my prepared remarks, we are going to offset that inflation, our target to offset that by price actions. We've started strong in the first quarter. You can see incremental leverage was up -- if the math is nearly 70% leverage in the first quarter sequentially and will continue to drive leverage.
We, of course, have to factor in all the uncertainty that's going on in the world. But teams committed to driving it and I would say in the long run, also I don't see why we can't get to the 30% to 40%. Hopefully, I answered your question, Brendan, on item one.
On your second item on operating cash flow, again, we have reiterated that we are -- and we started the year with 90% to 100% free cash flow conversion. We told you that at Investor Day, we reiterate. We have a path to get to the 90% to 100% free cash flow conversion. The first quarter at a 47% conversion was pretty much what we expected. It was all in the guide in the 90% to the 100%.
The first quarter conversion is driven by two pieces. One is higher compensation expenses from a year-over-year basis as we paid out. And secondly is higher investments in sustainability that we had also called out. But if you look at history of 3M, the first quarter is always the lowest from a conversion rates than you build. So, we still see a path to the 90% to the 100%.
Outstanding. Thank you guys.
Our next question comes from Deane Dray with RBC Capital Markets. You may proceed with your question.
Thank you. good morning.
Good morning Deane.
A question for Monish, please. Just on the FX assumption for the year, 3M, historically, has been one of the few companies that actually use financial hedges on FX. Is this still in place? And there's typically a lag when you use those hedges, so -- versus what you're seeing in the spot market? Just what's -- I can see you've got that 1% to 2% in guidance, but are the hedges at play?
Yes. So, we do cash flow hedging, Deane, and that's been done even before my time. The team continues to do that as per the rules that are out there. For the first quarter, it was a -- FX was a $0.04 headwind and then on a revenue, it was a 2% headwind.
If you just take -- and it's very volatile, it's all due to the strength of the US dollar. But if you just had to snap the chalk line a week ago and say, if that's what the trend is for the future, I would say on a revenue basis, it's somewhere between 1% to 2% impact.
And then from an EPS perspective, it's a $0. 05 to $0.10 headwind we've taken $0.04, so then you'll have another $0.01 to $0.06 again, it's very volatile, Dean. So, it's really hard. I'm just giving you a point in time based on just snapping the chalk line a week ago on those currency rates.
That’s helpful. Thank you.
Our final question comes from Nigel Coe with Wolfe Research. You may proceed with your question.
Sorry about that. Thanks again for the -- it wasn't mute button issue. I just want to make that very clear. So, -- thanks again. So, just to put a finer point on the guide. I mean you've acknowledged the dollar stronger raw material pressure, China, Europe. So, lots of incremental headwinds, but what is the offset to that, Monish, in terms of keeping the range essentially unchanged?
So I'll start with just – you take the top line growth at 2% to 5% that we came into the year with, we continue to see that, Nigel, play itself out. If you take GDP IPI, that's growing, give or take, 3% to 4%. And you take auto build rates, which are still at the 5% growth rate. We have told you we can get 300 to 500 basis points of out build in the long term. You saw in this quarter, the team did on a negative 5% order growth rate they came in at plus – were flat. So it's 500 basis points.
Health care started slow in January and February, we still see ourselves getting to in US elective procedures, 95% to 100%. You look at OCS or oral care, we are starting to see that back. Again, January was down due to the Omicron variant, but we have seen that back up. And then consumer is – we said low to mid-single digits. That's where they delivered in the first quarter. So that remains as is. So I would say when you look at all of this from a macro perspective for the year as a whole, it's – we still see ourselves in that range of 2% to 5%.
And of course, we continue to get more price to offset the inflation. So that's number one. I would say, secondly, we did bring out the second quarter, because we wanted you all to know what we are seeing from a headwinds perspective, I'm sure you're hearing it from all industries, and we are not telling you anything new that you haven't heard from others. And then on EPS, which is $10.75 to $11.25, I go back to volume gives us the best leverage. So the 2% to 5% growth there plus the continued work that the teams are doing to drive productivity in the factories, strategic sourcing, continuing to be smart about investments in the growth productivity and sustainability.
All of that put together, we see the calculus that gets us to the $10.75 to the $11.25, and that's what we are working towards. I think things will play out as they will play out in the short run. But again, I go back to long-term growth about macro margin expansion and cash, it's clearly doable and these short-term headwinds will all play itself out.
Okay. That's great. And I know we're running late here. So – but it seems like you're working around the Belgium facility issue, which is just good news. But it seems to me – and maybe this is a question for Mike, that Belgium was a symptom of a broader problem, which is to date, we've had litigation actions against PFAS, and now it seems to be more operational. And your Germany, I know was supposing to phase out PFAS products. California has got some similar proposals as well. So how is the Board thinking about this, number one? And then secondly, how material could this be for 3M longer term? Just any color there would be helpful. Thanks.
Yeah. Nigel, maybe I'll just try to kind of frame this up a little bit. So there are two parts to what we're managing in Zwijndrecht and I would say, in our manufacturing sites around the world, there's a historical impact of the PFAS chemistries, PFOA-PFOS that we exited and announced the exit almost 20 years ago now and – or exit almost 20 years ago. And then there's ongoing operations. And so we're working on both of those in Zwijndrecht as the charge that we announced in March was to resolve remediation related to that historical PFOA-PFOS manufacturing.
And then we're working with the authorities and Flanders around an operating permit going forward. And that's something that we've been doing around the world at our five sites with regulatory authorities and continue to do that. It's – PFAS continues to be a critical PFAS substances. There's more than 4,000 of them. We continue to have some PFAS in our products that is critical to customer needs in health care, electronics, automotive. And so the -- its something we’re managing with those sites, managing with those authorities and something we'll keep you updated on as appropriate as we go forward.
Thank you.
That concludes the question-and-answer portion of our conference call. I will now turn the call back over to Mike Roman for some closing comments.
To wrap up, we had a good start to the year with solid growth, sequential margin expansion and strong cash generation. We are positioned for a successful 2022, and we'll stay focused on taking care of our customers, driving growth and improving our operational performance. Thank you for joining us.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.