3M Company (MMM) — Q1 2022 Earnings Call Transcript

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 by 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 sided 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 the 3M site and in the surrounding area. To help reduce the impact on 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 on 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 in 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 a $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 in 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.

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 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 headwinds. 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 benefits 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 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 above 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 partnerships 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.

Hey, guys. Good morning.

Good morning, Steve.

Good morning, Steve.

Can you provide more detail on the second quarter? It seems there are several moderate downward revisions to some of the assumptions, and I'm not entirely clear on how the guidance is being reaffirmed. Are you indicating that it remains within the range, but closer to the lower end? Just those two points to start.

Sure, Steve. I'll begin with the overall guidance for the year. As you know, we don't provide quarterly guidance. So coming into the year, we anticipated organic growth of 2% to 5%. We still believe that this range is achievable, with no changes from our previous outlook. We shared the second quarter outlook to assist you in modeling within the current macroeconomic environment. The beginning of April was slower, primarily due to issues in China, and we are waiting to see how quickly they recover once the lockdowns are lifted. Observing past trends, we expect a ramp-up once restrictions are eased. Some macro trends in the automotive and consumer sectors have shown a sequential decline, attributed to semiconductor and chip shortages. However, healthcare is improving, moving from 85% to 90% and then to 95%. Overall, we remain confident in reaching the previously stated organic growth range of 2% to 5% and adjusted earnings per share of $10.75 to $11.25. Market demand was strong in the first quarter, despite the challenges in China, and we see overall strength in the markets. While uncertainties may play out over the year, we maintain a positive outlook for the long term and the current year.

Got it. Great. Thanks a lot.

Yes. Thanks, Steve.

Good. Thank you. Good morning, everyone.

Good morning.

Good morning, Scott.

I believe many of the concerns you raised this morning are similar to issues we've observed elsewhere. Could we discuss pricing a bit more? I understand you no longer break it out as a separate line item, but maybe you could provide some broader insights. Last quarter, your prices increased by 2.6%, and your core volume this quarter is around 2%, which suggests that pricing might be slightly better than that and volumes are relatively stable when compared on a similar basis. Can you also discuss your goals for price and cost parity? Given the increased costs seen even in the past month, when do you anticipate achieving price cost parity? Is it possible this year, and if so, when? Additionally, it seems like our prices are still on an upward trend. I'll leave it at that. Thank you.

Sure, Scott. The team did an excellent job. As I've mentioned regarding our tools and daily management, we started slowly on pricing last year at 0.14%, increasing to 1.4% in Q3 and 2.6% in Q4. This quarter, we maintained our momentum, driven by the carryover impact and new pricing. As I stated in my prepared remarks, we more than compensated for inflation. If you calculate it on a rate basis rather than just on a dollar basis, we achieved over a 3% price increase this quarter. The team is focused on addressing the additional inflation we're seeing and is already working on raising prices. As I mentioned, our goal is to counterbalance the extra inflation with higher prices, marking a solid start to the first quarter.

Okay. Thank you.

Nigel, are you there?

Operator, why don't we move to the next question please?

Hi, good morning.

Good morning.

Good morning. I have a question regarding the Belgian plant and the remediation measures you mentioned. This topic has come up frequently in recent months, and we've received similar inquiries from investors about the plant. Can you clarify the role of this plant in relation to 3M's overall operations? What impact do the production issues at the plant have on your current guidance, especially since we have a complete quarter behind us? Additionally, what is the status of inventories at the plant that would allow for continued shipments even without full production?

Yes, Julian. As we've discussed previously, we have experienced some operational shutdowns at that plant, and we are continuing to work with local authorities on updating the necessary permits. We are focused on resolving these issues as we are a key supplier from that plant for specialty fluids, including heat transfer fluids used in the semiconductor industry. Zwijndrecht is crucial for supplying these materials to our customers, and we are making every effort to resolve the disruptions so we can maintain our supply. Additionally, we are exploring the possibility of utilizing capacity at alternative sites when feasible. We observed an impact in the first quarter, which is reflected in our outlook, and we are collaborating with customers to manage any ongoing disruptions. We will keep you informed as we take steps to mitigate these impacts and will provide updates as needed 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.

Hey. Thank you. Good morning, everyone.

Hi, Jeff.

Good morning, Jeff.

I was considering the adjusted framework, and I didn't have the opportunity to review all the restatements. Just to clarify, for the future, are we excluding litigation and environmental-related costs both going forward and in the way you restated the numbers?

I'm not sure I follow, Jeff, but you're asking if we will proceed on a go-forward basis. Yes, we have made the adjustment that going forward, all costs for significant litigation matters will be shown as an adjustment to our earnings. You will see the GAAP EPS number, which is reported along with the adjusted earnings per share. We have also filed an 8-K restating the history. To give you context, as Bruce mentioned in his prepared remarks, for example, in 2021, we would have excluded approximately $0.61, which represented costs for significant litigation matters, as an adjustment, amounting to a 140 basis points impact on margin.

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. At the end of the day, the first results are GAAP EPS, and we can't overlook that. We separated this into two categories because many investors requested clearer insights into the underlying performance of our business. We disclosed $90 million last year and are doing so again this year to remind everyone of the previous disclosure. There was also a request for transparency regarding our litigation-related expenses, which we have categorized as a separate line item. You can view it either way; ultimately, GAAP EPS comes first, followed by the adjustments. This should help clarify our spending on litigation and provide better insight into our underlying business. I hope that clears things up.

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 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.

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. I would like to begin by referencing Mike Vale’s comments from Investor Day, where he emphasized that one of his main priorities is to continue driving margin expansion. We observed this trend sequentially. We anticipated that the year-on-year comparison would be challenging due to inflation, as you noted. However, the team has successfully maintained momentum on all fronts, including pricing, reaping the benefits of restructuring, and enhancing productivity in our factories, while also investing in growth aligned with our key platforms, which was evident in the first quarter. Our mask respirator results were better than expected. Initially, we projected a sequential decline of $100 million to $150 million, but it turned out to be only a $50 million decrease, indicating stronger performance. We will need to monitor how the rest of the year unfolds for the mask respirator segment to see where it ultimately settles. It is important to acknowledge that it does affect our incremental margin as we had anticipated a decline of 700 year-over-year. In summary, Mike Vale and his team are committed to driving margin expansion, and as the productivity, pricing, and restructuring initiatives take effect and stability returns, we expect to see positive impacts on margins. Thus, it has been a solid 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 the Zwijndrecht charge in Q1. So, yes, the remaining $0.60, we took roughly $0.13 here in Q1.

Thank you.

Yes.

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. When we provided our guidance back in February, the range of $10.15 to $10.65 included a plan for about $0.60 related to ongoing litigation concerning PFAS, combat arms, and respirators. Additionally, we had an extra $0.26 charge that we announced on March 30th, which brings the total to $0.86. Regarding cash, that's hard to pinpoint exactly when it will happen. For example, the $0.26 charge from Q1 will be disbursed over time as remediation actions are taken. It's also essential to note that there is no expected forecast regarding updates to reserves. Therefore, our cash flow will be driven by these factors, but it won't align perfectly.

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.

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?

Certainly, Andrew, you pointed out some specific challenges. The supply chain issues are affecting all of our businesses, leading to disruptions in raw materials, logistics, and inflation, which are impacting our entire portfolio. In the first quarter, we saw organic growth of 3% in the consumer segment, building on a 9% increase from last year, and this growth was observed across all divisions. Consumer health and safety products, along with our home care and home improvement lines, are driving this growth. Overall, we're experiencing solid performance without any specific negative impacts. Aside from some disruptions from our Zwijndrecht facility, these supply chain issues aren't concentrated in one part of our portfolio; there is also a geographical impact related to some COVID effects. In healthcare, we are still looking for a rebound in elective procedures. As Monish mentioned, while the macro outlook in some certain end markets is softening, it's less about supply chain disruptions and more about broader market slowdowns, particularly in sectors like automotive and electronics, which are affected by semiconductor shortages.

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 mergers and acquisitions strategy is a key aspect of our capital allocation. We view it as a significant opportunity to create value. We focus on attractive, higher growth markets that can utilize 3M's capabilities, including our technology, manufacturing expertise, and global customer reach. This focus guides our M&A strategy. When we identify companies that can be integrated into 3M and allow us to capitalize on our strengths, that directs us towards more appealing, higher-growth market opportunities, whether in electronics or any of our four business sectors.

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.

I'll begin with your question about operating leverage, Brendan. Our long-term target for incremental leverage is still 30% to 40%. When you consider our gross margin, which is between 45% and 50%, reaching that 30% to 40% is feasible. Volume growth provides the best leverage, so the more we can expand, the more incremental leverage we will achieve. Additionally, improvements in factory productivity and strategic sourcing will contribute to this leverage, along with ongoing management of litigation matters. Therefore, we believe that a long-term target of 30% to 40% is achievable. We initially guided towards this range for the year, closer to 30%. Looking at the current midpoint of our guidance, which reflects 2% to 5% revenue growth and earnings per share between $10.75 and $11.25, adjusting for foreign exchange impacts could add 1% to 2%. We are currently at 2% for the first quarter, and if this trend continues, we will still aim for the 30% target. While we are experiencing higher inflation, we plan to mitigate its effects through price adjustments. We started off strongly in the first quarter, achieving nearly 70% leverage sequentially, and we are focused on continuing to drive that leverage. Of course, we need to consider the global uncertainties, but our team is committed to this goal, and I believe we can reach the 30% to 40% target in the long run. Regarding your second question about operating cash flow, we have consistently communicated our goal of achieving 90% to 100% free cash flow conversion. This was reiterated at Investor Day, and we have a clear path to achieving this target. Our first-quarter conversion rate of 47% was in line with our expectations, reflecting the guidance of 90% to 100%. This conversion was impacted by two main factors: increased compensation expenses compared to last year and higher investments in sustainability. Historically for 3M, the first quarter typically shows the lowest conversion rates, but we anticipate improvement, maintaining the expectation of reaching 90% to 100%.

Outstanding. Thank you guys.

Thank you. good morning.

Good morning, Deane.

I have a question for Monish regarding the FX assumption for the year. Historically, 3M has been one of the few companies that utilize financial hedges for FX. Is that practice still being maintained? There is usually a lag when these hedges are used, so how does that compare to what you're observing in the spot market? I understand you have provided guidance of 1% to 2%, but are the hedges being factored in?

Yes, we do cash flow hedging, and that has been in place even before my time. The team continues to follow the established rules. In the first quarter, the foreign exchange impact was a $0.04 headwind and represented a 2% headwind on revenue. This is quite volatile and largely due to the strength of the US dollar. If we look at current trends, I would estimate a future revenue impact of between 1% to 2%. From an earnings per share perspective, we are seeing a headwind of $0.05 to $0.10; we've already accounted for $0.04, so we may see another $0.01 to $0.06. Again, this is very volatile, so it's challenging to provide a definitive outlook, but this is based on currency rates observed about a week ago.

That’s helpful. Thank you.

Apologies for that. I want to clarify that the issue wasn't with the mute button. Thank you once again. To clarify the guidance, you've acknowledged the stronger dollar and the raw material pressures in China and Europe, which present several additional challenges. What are the mitigating factors, Monish, that allow us to keep the range relatively stable?

I’ll begin by mentioning that we are maintaining our top line growth forecast of 2% to 5% for the year. We believe we can still reach the adjusted earnings per share target of $10.75 to $11.25. There have been no changes to that outlook. Overall, market demand has remained strong in the first quarter, aside from the situation in China. We see strength in the markets overall. Time will reveal how some uncertainties will unfold throughout the year, but we remain optimistic about the long term and the year ahead.

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.

Sure. There are two aspects we are managing in Zwijndrecht, as well as across our manufacturing locations globally. First, there is the historical impact of PFAS chemistries, particularly PFOA and PFOS, from which we announced our exit nearly two decades ago. Second, we are focused on ongoing operations. The charge we announced in March was related to the remediation of the historical PFOA-PFOS manufacturing. We are also collaborating with authorities in Flanders regarding an operating permit for the future. This effort mirrors our work at our five sites around the world, where we are continuously engaging with regulatory authorities. PFAS remains a significant concern, as there are more than 4,000 substances classified as PFAS. We still incorporate some PFAS in our products that are essential for meeting customer requirements in sectors like healthcare, electronics, and automotive. We are actively managing these issues with the respective sites and authorities and will keep you updated as necessary.

Thank you.

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.