3M Company (MMM) — Q2 2023 Earnings Call Transcript

Thank you and good morning, everyone and welcome to our second 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 Kevin Rhodes, our Chief Legal Officer. Mike, Kevin, and Monish 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'll 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. With that, please turn to Slide 3 and I will now hand the call off to Mike. Mike?

Thank you, Bruce. Good morning, everyone and thank you for joining us. In the second quarter, we made significant progress on the important actions we have been taking to improve our performance and shape the future of 3M. We posted adjusted organic growth of negative 2.5% which includes a negative 1.7% headwind from the expected decline in disposable respirator sales. Revenue for the quarter was at the high end of our guidance range. Our adjusted operating margin was 19.3%, impacted by restructuring charges of $212 million or a headwind to adjusted operating margin of 2.7 percentage points. Excluding these charges, we increased operating margin year-over-year. We delivered adjusted earnings per share of $2.17 and adjusted free cash flow of $1.5 billion driven by continued improvements in inventory management. Today, we are updating our full year earnings per share guidance to $8.60 to $9.10, up from a previous range of $8.50 to $9. We remain confident in our ability to deliver on our commitments, realize additional benefits from our restructuring actions, and position 3M for the future. In the quarter, we maintained a strong focus on serving customers, driving operational execution, and maintaining spending discipline. All business segments delivered sequential improvement in adjusted operating margins. Our restructuring actions and strong focus on cost management drove these margin improvements. Looking at our markets, trends played out as expected. We saw strength in automotive, both OEM and aftermarket, as well as highway infrastructure and personal safety, excluding disposable respirators. Health Care, which was up slightly, continues to be impacted by lower post-COVID-related demand, notably in our Biopharma, Health Information, and Medical Solutions businesses. We also saw continued weakness in electronics, consumer retail, and China. Please turn to Slide 4. As we focus on improving our performance and managing a dynamic external environment, our teams are driving 3 strategic priorities: improving operational execution, successfully spinning off our Health Care business, and addressing litigation. We are on track with our restructuring actions and have made significant progress in leaning out the center of the company, simplifying our management structure, and streamlining our supply chain. The changes to our enterprise supply chain organization are enabling improvements in service, cost, and inventory which helped drive our second quarter results. We are also taking advantage of the continued healing and supply chains to reduce logistics costs and improve production yields. We've also made progress in advancing our go-to-market models to bring our innovation closer to customers. In support of these changes, to date, we have initiated the transition to a new export model in 24 countries. I am pleased with how these changes are helping drive performance. We've made good progress on our planned spin of our Health Care business, including regulatory filings and system updates in preparation for the soft spin. We are also in the final steps of naming a CEO. We continue to work towards closing the transaction by year-end 2023 or early 2024, subject to the required conditions and additional factors we have disclosed in our SEC filings. Last month, we announced an agreement, subject to court approval, to resolve public water systems claims nationwide in the AFFF multi-district litigation. This agreement will benefit U.S.-based public water systems that provide drinking water to a vast majority of Americans. The settlement covers all forms of PFAS. As we announced, we have taken a Q2-related charge of $10.3 billion payable over 13 years. Also related to litigation, we continue to participate in the confidential mediation process as part of the Combat Arms MDL and we'll provide updates as appropriate. To provide additional details on our PFAS settlement agreement, I will now turn the call over to Kevin. Please turn to Slide 5.

Thank you, Mike and good morning. This is an important step forward for 3M. As Mike said, we have entered into a broad class resolution with public water systems that provide drinking water to the vast majority of Americans. We are taking a proactive approach to managing PFAS by establishing a more certain path forward for public water systems, communities, and 3M. Subject to court approval, 3M has agreed to support PFAS remediation for public water systems that detect PFAS at any level and our agreement addresses all PFAS, not just those compounds that have been the primary focus of litigation to date. Our agreement also provides funding for eligible public water systems that may detect PFAS in the future and we have agreed to fund additional testing by public water systems as well. As Mike shared, the agreement terms entail a present value commitment of $10.3 billion paid over 13 years. Additional details regarding the payment schedule are available in our Form 8-K filed in June. While this agreement provides an alternative to continued litigation for class members and for 3M, we remain prepared to defend ourselves in litigation should the agreement not receive court approval or should public water systems choose to litigate instead. We are building on actions 3M has taken and continues to take. We were the first company to exit the manufacturing of 2 forms of PFAS, namely PFOA and PFOS, which we announced more than 20 years ago. We have invested in state-of-the-art water filtration technology in our chemical manufacturing operations. And we have announced that 3M will exit all PFAS manufacturing by the end of 2025. We will continue to build on this important progress as we focus on the future and work to proactively manage PFAS. Now, let me turn it over to Monish to provide more details regarding our performance in the quarter.

Thank you, Kevin, and I wish everyone a very good morning. Please look at Slide 6. In the second quarter, our performance was driven by a strong commitment to our customers, enhancing manufacturing and supply chain productivity, and maintaining strict spending discipline. During this quarter, we also kicked off a significant part of our restructuring plan to simplify and streamline our organization. We are actively reducing management layers and rooftops while enhancing our go-to-market strategies and supply chain to bring us closer to our customers. Market trends are evolving as expected, with ongoing challenges in electronics, weak discretionary spending in consumer retail, and varied performances in industrial end markets. In China, the recovery has been gradual, influenced by electronic sales and soft export trends. Europe continues to face challenges due to ongoing geopolitical uncertainties, while the U.S. market remains mostly stable. Total adjusted sales for the second quarter were $8 billion, representing a decrease of 4.7% year-on-year. This result was slightly better than expected, as we encountered a smaller-than-anticipated negative effect from foreign currency translation, which was down by 0.9% compared to a forecast of minus 2%. Organic sales on an adjusted basis fell 2.5% year-on-year. This figure included an anticipated year-on-year decrease of about $140 million, or 1.7 percentage points, stemming from a drop in demand for disposable respirators. Excluding this effect, adjusted organic sales for Q2 declined by 0.8%. On an adjusted basis, our operating income for the second quarter was $1.5 billion, with operating margins of 19.3%, and earnings per share of $2.17. These results included pretax restructuring charges of $212 million, which negatively affected adjusted operating margins by 2.7 percentage points and earnings by $0.31 per share. If we exclude the restructuring impact, second quarter adjusted operating margins improved to 22%, marking an increase of 40 basis points from the previous year, with earnings rising to $2.48, a gain of $0.03 year-on-year. Additionally, while lower sales volumes and inflation posed challenges, we effectively managed to surpass these obstacles through enhanced manufacturing productivity, strategic restructuring, strong spending discipline, and effective pricing, which collectively improved margins by 1.4 percentage points and increased earnings by $0.15. The previously indicated headwind from disposable respirators negatively impacted operating margins by 50 basis points and earnings by $0.09 per share. The ongoing effects of inflation in raw materials, logistics, and energy created an additional year-on-year challenge of approximately $30 million, resulting in a negative impact of 30 basis points on operating margins and $0.04 on earnings. Foreign currency translation accounted for a negative 0.9% effect on total sales, leading to a 20 basis point headwind to margins and a $0.02 decrease in earnings per share. While divestitures, particularly in Food Safety, did not affect margins, they contributed a year-on-year hit of $0.03 to earnings per share. On the other hand, miscellaneous financial items contributed a net increase of $0.06 per share year-on-year, mainly due to a lower share count, albeit partially offset by a lower non-operating pension benefit. In summary, our team's dedication to enhancing productivity, implementing restructuring measures, and controlling spending is beginning to show results. These efforts, together with improvements in global supply chains, led to a sequential enhancement in adjusted operating margins across our business segments. Excluding restructuring charges, adjusted operating margins saw a sequential rise of 3.6 percentage points. Please move on to Slide 7. In the second quarter, adjusted free cash flow reached approximately $1.5 billion, reflecting a 44% year-on-year increase, with a conversion rate of 122%, an increase of 50 percentage points compared to the second quarter of last year. This improvement was fueled by our focus on managing working capital, particularly inventory, and timing related to restructuring charges. Inventory remained stable compared to the typical historical increase from Q1 to Q2. We continue to adjust production levels based on market demands and utilize daily management and data analytics to enhance inventory turnover rates. In the quarter, adjusted capital expenditures totaled $328 million, similar to last year, as we persist in investing in growth, productivity, and sustainability. We returned $828 million to shareholders through dividends during the quarter. At the conclusion of Q2, our net debt stood at $11.7 billion, a reduction of 12% year-on-year. Our business segments continue to demonstrate strong cash flow generation. Furthermore, our reliable access to capital markets, along with the anticipated one-time dividend from the spin of Health Care at 3 to 3.5 times EBITDA and a 19.9% retained stake, will offer us additional financial flexibility. Combined with our current strong capital structure, this allows us to invest in the business, return capital to shareholders, and accommodate cash flow needs related to ongoing legal matters. Now, please turn to Slide 9 for insights on our business group performance. Beginning with our Safety and Industrial division, which reported sales of $2.8 billion, down 4.6% organically. This outcome included a year-on-year headwind of roughly $140 million due to the decline in disposable respirators from last year. Excluding these respirators, Safety and Industrial sales grew by 0.2% organically in Q2. Organic growth was primarily fueled by mid-single-digit increases in roofing granules and automotive aftermarket products, while personal safety saw a decline linked to last year's disposable respirator comparisons. However, excluding these respirators, the personal safety segment recorded high single-digit organic growth. Sales in closures and masking dropped due to decreased packaging and shipping activities, while industrial adhesives and tapes faced challenges from softness in the electronics market. Adjusted operating income for Safety and Industrial was $614 million, a 2.4% decrease year-on-year. Adjusted operating margins were at 22.2%, an increase of 70 basis points compared to last year and up 2 percentage points sequentially. This year-on-year margin enhancement stemmed from productivity initiatives, stringent spending control, and pricing strategies. However, these benefits were partially countered by drawbacks from lower sales volume, restructuring expenses, and inflation impacts. Moving on to Transportation and Electronics, as detailed on Slide 10, this segment achieved Q2 adjusted sales of $1.9 billion. Adjusted organic growth fell by 2.4% year-on-year, primarily due to continued decline in electronic demand. Our auto OEM sector saw an increase of about 21% year-on-year, exceeding global car and light truck production by approximately 600 basis points. However, our electronics segment faced challenges due to soft market demand, leading to an approximate 22% year-on-year drop in adjusted organic sales. The outlook for electronic end markets remains highly uncertain, and we forecast year-on-year organic growth rates in electronics will remain negative in the latter half, although expected to improve compared to nearly 30% decline in the first half. Within Transportation and Electronics, transportation safety experienced high single-digit organic growth, while other areas saw mixed growth rates compared to last year. The adjusted operating income for this segment was $369 million, down 19% year-on-year, with adjusted operating margins of 19.8%, a decrease of 3.6 percentage points year-on-year, though a sequential rise of 3.1 percentage points. Margin pressures originated from sales volume declines, restructuring costs, and inflation impacts, but these were partially mitigated by strong spending discipline, productivity improvements, and pricing strategies. Reviewing our Health Care segment on Slide 11, Q2 sales reached $2.1 billion, reflecting slight organic growth compared to last year. Organic sales in oral care increased by low single digits year-on-year, while the Medical Solutions sector also saw slight growth. Separation and purification, along with Health Information Systems, experienced mid-single-digit and low single-digit declines, respectively, due to decreased post-COVID-related biopharma demand and ongoing strains on hospital budgets. As procedure volumes begin to improve and hospital budgets stabilize, we remain optimistic about the long-term prospects for this business. Health Care's operating income for the second quarter was $411 million, a 16% decrease year-on-year, with operating margins at 19.8%, down 2.8 percentage points year-on-year but up 1.9 percentage points sequentially. The decline in operating margins year-on-year was affected by lower sales volumes, restructuring charges, and inflation impacts, although some of these challenges were offset by benefits from strong spending discipline, productivity enhancements, and pricing strategies. Lastly, on Slide 12, our Consumer segment reported second quarter sales of $1.3 billion with organic sales decreasing by 2.2% year-on-year, as discretionary spending in hardline categories remains weak. We anticipate this trend to persist into the latter half of the year, with slight organic sales growth observed in home, health, and auto care, while home improvement and stationery businesses both faced decline. Consumer's operating income for the second quarter was $235 million, down 5% year-on-year, with operating margins at 18.2%, a decline of 40 basis points year-on-year but an increase of 3.2 percentage points sequentially. The year-on-year operating margin decrease was primarily driven by lower sales volumes, restructuring expenses, and inflation impacts, although these challenges were partially offset by productivity actions, stringent spending control, and effective pricing. That concludes our commentary on the second quarter. Please look at Slide 14 for an update on our full-year expectations. In our January earnings call, we mentioned that we anticipated macroeconomic and end-market uncertainties to persist throughout the year. We also pointed out that signs of healing in supply chains were emerging, although we expected to face ongoing raw material availability issues and inflation, albeit at lower levels than in 2022. Moreover, we expressed dissatisfaction with our performance and indicated our intention to scrutinize our operations more closely as we prepared for the spin-off of Health Care. Consequently, we signaled that we would implement additional measures throughout the year to enhance supply chain performance, streamline operations, and strengthen our connection with customers. While we still have work ahead, I want to highlight some of the progress we've made in the first half of the year. Regarding our sales performance, even as end markets unfold as expected, Q1 and Q2 revenues slightly exceeded our forecasts. Our teams have maintained a steadfast focus on serving customers, addressing backlogs, and leveraging data analytics to enhance demand planning. We are actively restructuring, on pace with our initiatives to reduce corporate and business segment structures as well as manufacturing supply chain levels. We have initiated the transition of 24 countries to an export model, collaborating with local distributors to meet customer needs in those markets. Additionally, we've made progress in streamlining corporate structures, such as exiting our aviation operations and our conference center in Northern Minnesota. We have also continued to adjust production output in response to market trends, manage inventory, and exercise strict cost control. Thanks to these efforts, alongside improvements in global supply chains and raw material availability, we achieved first-half performance that exceeded expectations, particularly in margins, earnings, and cash flow. In the first half of the year, on an adjusted basis, we reported sales of $15.7 billion, operating margins of 18.6%, and earnings per share of $4.14. These results included $264 million in pretax restructuring charges, representing a headwind to margins of 1.7 percentage points and to earnings of $0.38 per share. Furthermore, our effective operational execution and working capital management, especially regarding inventories, facilitated the generation of $2.3 billion in adjusted free cash flow, with a conversion rate of 105%. Turning to our guidance; we are raising our full-year adjusted earnings expectation due to our strong operational performance in the first half, reflected in an improved margin rate. We now project full-year earnings to fall between $8.60 and $9.10, compared to a previous range of $8.50 to $9. We are closely monitoring trends across all our businesses, particularly in electronics, consumer retail, industrial sectors, and China, and have not yet observed signs of improvement. As such, we currently anticipate organic growth to trend toward the lower end of our flat to minus 3% range. This projection also takes into account the year-on-year headwind from disposable respirators, which is expected to be toward the high end of our expectations at about $550 million, alongside persistent macro and market uncertainties. Our forecasted full-year adjusted free cash flow conversion expectation remains stable, in the range of 90% to 100%. Looking ahead to the third quarter, we expect market trends will largely mirror those of Q2. Consequently, we estimate third quarter adjusted sales to be around $8 billion. The impact of the decline in disposable respirators and last year's exit from Russia is expected to pose a year-on-year sales headwind of approximately $130 million or 1.5 percentage points. For the third quarter, we anticipate pretax restructuring costs to fall between $125 million and $175 million, alongside expected benefits of $125 million to $150 million. Overall, we project that third quarter adjusted earnings per share will be in the range of $2.25 to $2.40. In conclusion, we maintain a strong commitment to serving our customers, enhancing supply chain execution, advancing our restructuring efforts, managing costs, and investing in the business amidst ongoing market challenges. We believe our initiatives will foster momentum and promote improvements in organic growth, margins, and cash flow as we move forward. I want to extend my gratitude to our customers and suppliers for their partnership and to the 3M employees for their dedication and hard work in delivering results for our customers and shareholders. I am confident in our future, and as we've stated, by the end of 2023, we will emerge as a stronger, leaner, and more focused 3M. That concludes my remarks, and we will now open the floor for questions.

Just a question on the outlook. I think operationally, second quarter was quite strong. And I appreciate your commentary on organic growth but where is the caution in terms of operational results in the second half? What segments, what verticals are you particularly sort of concerned about, as I said not to raise guidance more given strength in the second quarter?

Thank you, Andrew. As I noted earlier, at the start of the year, we expected market conditions and economic uncertainty. In the first half of the year, electronics have remained soft, with nearly a 30% decline. Consumer spending, particularly in discretionary areas, has also been weak. China experienced similar softness in the first half. Looking ahead to the second half, we are monitoring the electronics sector to determine if it has reached its lowest point, though we expect continued softness in that area, resulting in a negative outcome for the year, but less severe in the latter half. We anticipate that consumer spending will stay soft, and we're keeping an eye on the back-to-school and holiday seasons. Industrial activity has shown mixed signals, with some markets performing well while others are experiencing destocking. We believe healthcare elective procedures will trend upward sequentially, yet Biopharma and Health Information Systems are still facing constraints due to COVID-related demands and pressure on hospital budgets, respectively. Additionally, our direct revenue is projected to be at the lower end of our range, estimating a decline of $550 million instead of the previously anticipated $450 million to $550 million. In China, the second quarter was weak, with a 4% drop on lower comparisons, and we have not yet observed a significant recovery. Moreover, last year’s third quarter presented a challenging comparison as China was emerging from COVID. Overall, third quarter trends appear similar to the second quarter. In light of our first half performance and the anticipated trends for the second half, we foresee being at the lower end of our revenue guidance range, originally set at flat to negative 3%. However, if there are changes in the markets, we are ready to respond. Our teams are executing effectively, as reflected in our announced results, with good momentum in supply chain operations and restructuring efforts aimed at cost management. We remain focused on prudent spending while being prepared to invest in growth within high-potential markets as they evolve through the latter half of the year and into 2024 and beyond. I hope that addresses your question, Andrew.

Yes. No, I mean it's still sort of margin was pretty solid. But let me drill down on consumer electronics maybe a little bit more. What would it take for this business to finally turn positive? Or is it just sometime early next year, the comps get so easy that it can decline anymore? But what KPIs in terms of end markets are you watching?

Yes, Andrew. I want to follow up on Monish's insights regarding our outlook for the second half. If you take a closer look at consumer electronics, we experienced a weak first half across all categories, including smartphones, TVs, notebooks, and tablets, which has affected our results as Monish mentioned. Looking ahead to the second half, there may be signs of recovery in the fourth quarter, but the third quarter is likely to resemble the first half. We're currently observing inventory levels in the channel, indicating some destocking during this slowdown, which we anticipate will continue in the electronics sector. As we approach the third quarter, this shapes our perspective. For improvement, we need to see a shift in demand reflected by the build rates in those markets, along with increased confidence visible in channel inventory. We are closely monitoring each of these consumer electronics categories and keeping an eye on semiconductor capacity and production changes, as these are good indicators of demand as well.

So I just want to delve in a little more into your margin performance in Q2 and what it means for your second half. I mean, obviously, you had a nice step-up in sequential margin despite absorbing the 2.7% of pretax charges. So how do we think about the durability of the productivity actions, the positive price versus cost that look like was going on in the quarter? And how do you think about margin performance embedded in Q3? And Monish, the second half as it looks like you're forecasting margin below Q2 and Q3.

Yes, Andy, let me address your question about sustainability and the cadence of restructuring charges and benefits. We've provided an appendix that outlines our expectations for 2023, which indicates that charges will be around $400 million to $450 million and benefits will match that range, indicating a self-funding scenario. Overall, the program entails total charges and benefits between $700 million to $900 million. In terms of timing, by the end of 2024, we anticipate that most restructuring charges will be realized, while the benefits will start to show up in 2025 and later. The net benefit from these actions is expected to fall within the same $700 million to $900 million range. Regarding margin performance, as you noted, we exceeded expectations in the second quarter mainly due to improved supply chain efficiency. Our factories have been optimizing production, and raw materials have been flowing more smoothly, enabling longer production runs. The efforts by our supply chain team, led by Peter Gibbins, are contributing to improved execution, and this is reflected in our results. Additionally, the team remains highly focused on controlling costs. Looking to the second half, we need to account for the restructuring costs on a quarterly basis, which will influence margin rates positively. At the beginning of the year, we projected an operating margin of around 18.5% to 19%. With a lower revenue and higher earnings per share, we now believe we can achieve a margin of approximately 19.5% to 20%, inclusive of all charges and benefits. As for raw material and energy cost inflation, we initially forecasted an impact of $150 million to $250 million for the year but have revised this down to $150 million to $200 million. This indicates we are starting to see some relief. We have observed disinflation—meaning inflation rates are lower than last year—and some improvements in logistics costs. However, certain commodities still face inflationary pressures, and labor costs remain sticky in this respect, which we expect will evolve throughout the year and into 2024. Additionally, as we prepare for the spin-off of our Health Care division, there will be costs associated with establishing the new management team, as Mike mentioned earlier. Regarding other financial metrics, we initially projected a year-over-year change of minus 10% to flat but are updating that to a range of minus 5% to plus 5%, with the midpoint reflecting no change. In the first half, we benefited from an adjustment of $0.11, while the second half will show a negative $0.11 on a year-over-year basis. I've provided a lot of information to help you as you build your models and assess our overall performance.

No, that's very helpful, Monish. And then just for the next question, maybe just a little more color into industrial businesses within Safety and Industrial. I think you'd guided to down low single digits for the year and you continue to be down mid-single-digit in Q2. I know last quarter, you described industrial markets as mixed, same description this quarter. But maybe you can characterize markets for us. Do you still see low single-digit decline for the year in industrial?

Yes, Andy, the quarter was down mid-single digits, influenced by the decrease in disposable respirators, resulting in a nearly flat quarter outside of that segment. As Monish mentioned, we anticipate a more significant decline in disposable respirators than initially expected for the year, which will also affect our third quarter. In terms of our product mix, we are experiencing some strengths in roofing granules and the automotive aftermarket, where demand for car repairs is robust. However, there has been some weakness in electrical markets and abrasives. Our industrial adhesives and tapes segment is feeling the effects from the electronics sector, impacting the broader industrial business. Outside of disposable respirators, personal safety is showing strong performance, with a high single-digit increase this quarter. There’s also a sense of caution among distributors regarding the outlook for industrial markets, as they notice improvements in the supply chain, leading them to reduce inventory. This situation is influencing our business performance as we proceed through the quarter and shape our outlook for the second half of the year. Additionally, the situation in China is contributing to these dynamics, with a slowdown in market activity and no signs of recovery yet as we approach the second half. This provides an overview of what we mean by mixed markets.

I'm curious, just overall, are you seeing areas or particular products or markets where you're getting some pressure to drop your prices, particularly given some of the weaker demand? Or do you feel like you can hold on to some of those price increases that you've gotten the last couple of years?

So yes, Scott, I would say Monish referred to it as disinflation, or a moderation of inflation. You're going to start having discussions about its impact on price. When we examine the situation, we believe our pricing is positioned correctly for our markets. Typically, the most discussions occur in retail markets. This is an ongoing topic, and it remains significant even during periods of high inflation. However, price is a concern everywhere. We are confident that our pricing is appropriate as we navigate these broader market dynamics. We're not experiencing pressure in any specific segment, but we do expect the conversation around pricing to increase as we see disinflation and eventually deflation.

That's helpful. I'd like to ask a broader question. When you mention supply chain streamlining, what does that entail? How do you balance localization with the need for resilience? I assume that resilience can sometimes lead to higher costs due to dependency on specific supply partners. How do you approach the cost-benefit analysis of streamlining, and could you provide a concrete example to clarify what you mean by that?

As we emerged from the pandemic, we faced numerous challenges affecting our supply chains, including inflation, labor shortages, and raw material availability, which created inefficiencies in our factories and impacted production yields. This year, we have started to see improvements in our supply chains, including better labor availability and an increase in raw material availability. During the toughest times, we focused on securing multiple sources for raw materials and engaged with many suppliers to manage interruptions. As conditions have improved, our emphasis has shifted to a narrower range of raw materials, which has led to better availability and more efficient factory operations. We have seen improving yields and logistics as these supply chains recover. As we proceeded with our restructuring, we reflected on the lessons learned during the pandemic and our restructuring phase, as well as our transition to a global operating model. The aim of streamlining is to capitalize on these insights and investments in data, analytics, and digital strategies to enhance productivity in our manufacturing processes. We are committed to improving every facet of our supply chain. This includes better and more disciplined planning, leveraging data and analytics, and enhancing our sourcing strategies. We are focused on optimizing the components of planning, sourcing, manufacturing, and delivery, making sure we learn from our plants' efficiencies and manage logistics more effectively. Furthermore, we are aligning our restructuring efforts with customer needs and our business models. This presents ongoing opportunities for improvement, and we will continue to refine our approaches. The restructuring was not merely about reducing headcount; rather, it was about rethinking and streamlining our supply chain processes to enhance our position in the market and prepare for stronger performance in the future.

I appreciate the additional details on the restructuring, Monish. My first question is about the deflationary point. It seems things are improving, possibly better than initially expected. Most of the inflationary pressures appear to have occurred for the year. Do you anticipate that to turn positive by the fourth quarter, or could it potentially improve in the third quarter numbers?

Yes, Joe, I believe it's important to break this down into several components. As I mentioned earlier, we're experiencing lower inflation compared to last year. Our challenges are estimated to be between 150 to 200 due to electricity and the ongoing effects of raw material inflation. In the first quarter, we managed around 100, and in the second quarter, we achieved approximately 25. We still have some carryover to address. Concerning new inflation, costs associated with logistics have decreased partly because we're using less premium freight now that raw materials are flowing more smoothly. However, inflationary pressures remain in downstream areas. While upstream materials are showing signs of easing inflation, labor costs downstream are still quite persistent. Therefore, we need to analyze each commodity and market individually. As we move into the third and fourth quarters, you should start to see improvements in costs on a year-over-year basis. Last year, we noticed peak inflation around October and November, followed by a moderation in markets. The situation will also depend on monetary policy and the demand we see from China and other end markets we're involved in. Overall, we believe the situation has improved, particularly regarding logistics. The flow of materials is better, which is certainly aiding our operations. We are seeing cost reductions, and the teams are effectively driving these efforts. However, it may take some time for these improvements to manifest, depending on our year-over-year comparisons and how much of that material gets consumed based on our production volume. It's a complex situation involving multiple materials, rather than just one.

Yes, that's super helpful. I guess my follow-on question, I know we talked a little bit about the weakness in electronics but I want to go back to it for a second. Is there a way to maybe just kind of parse out exactly what you're seeing in that end market? And then specifically, I know that Apple is considering rolling out like an all-OLED iPad next year. And I know when we went through that transition a few years ago on smartphones. That was a hot topic for your company. Any thoughts just around that specifically and how that impacts your business?

Yes, Joe, I’ll reiterate my earlier comments. The decline we’ve observed in the first half has mainly been due to decreased demand in smartphones, tablets, and TVs among other categories. There is a continuing transition in display technology from LCD to OLED, which we have discussed in the past. We are still innovating on our OLED platforms, but we are experiencing some effects from this transition as we observe a consistent shift away from LCD to OLED in several categories. The more significant impact, however, stems from the overall demand in end markets such as smartphones, TVs, tablets, and laptops.

I wanted to ask on the restructuring program. So for Q3, if you just annualize the expected savings, it's about $500 million to $600 million which isn't far off the full $700 million to $900 million range which sounds like we shouldn't expect in 2025. Is there any reason that the savings are maybe tracking a little bit ahead? Is there anything that's front-weighted that we should be aware about here?

Yes, Chris, that's an excellent question. Your calculations are accurate. I would also consider the fourth quarter, where we have projected figures between $185 million and $235 million. If you take the midpoint and annualize it, it gets us closer to the overall annual range. However, when you examine our charges, some relate to rooftops, some are noncash charges, and some are associated with restructuring personnel. In total, for the first half, we have accounted for $262 million. Regarding your question about what's anticipated for 2024 and beyond in terms of costs, several factors come into play. We conduct negotiations on a geographical basis to ensure compliance with all regulations, which will incur costs. Additionally, there are some rooftops that take longer for us to exit, which will also affect us in 2024 and beyond. This is why you're seeing the current situation as it is.

Okay. Yes, I appreciate that. And then, it certainly feels like the savings here are coming in a bit quicker maybe than previously thought. I did not think there's anything in the guide for Q2 restructuring savings which obviously came through. Does that change the way you think about the plan over the next couple of years into 2025, just seeing the savings come through faster than you thought?

Yes, I would say, listen, on Q2, the teams knew that we had to execute well and early and they've done a nice job. Some of the benefit came from head count. But a lot of the other benefits that we've got, as Mike mentioned about streamlining the corporate, we were able to go after a lot of indirect costs in those areas, including exiting some of the rooftops that we wanted to that we were planning to early. So again, it goes back to a lot of focus on cost control, making sure that where we are spending our money on an indirect perspective also is well focused on. And that's where we were able to get to be off to a better start than we expected. So I give the team a lot of credit. They're going through very granular levels of detail, making sure that we are doing the right amount of spend and focusing in the right place as we get the best return. So my credit to the team.

Maybe just starting with biopharma. So this is an area where we've seen weakness post-COVID for some time now. Have there been any green shoots there? I don't know if you think about like orders or what customers are saying about spend to the second half?

Biopharma has been a significant contributor to solid growth in healthcare, reflecting the post-COVID environment. We experienced strong demand for vaccines and therapeutics, and the industry has ramped up to meet that need. Currently, we are witnessing the effects of that demand along with the need to deplete the inventory that was accumulated. Both aspects are in play. We see a tremendous opportunity for innovation and believe that this will drive long-term growth for our business. Our new solutions, which allowed us to combine multiple processing steps into one, illustrate the value we've brought to the vaccine and therapeutic opportunities. The demand in this area will continue. Looking ahead, recombinant protein therapeutics present a promising opportunity as we navigate the post-COVID landscape, managing both end-market demand and inventory across the broader channel.

Nicole, I'll add one more is we are very confident and bullish about this business. In fact, we have added capacity to continue to have more production output out there as the demand comes back.

Got it. And just to clarify, in your second half outlook, like what's baked into the Health Care business? Have you embedded any improvement in biopharma? Or is the expectation that that's more of a 2024 dynamic?

So as I've mentioned, there is slight improvement that you're going to see overall in Health Care. One is elective procedures should go up. Biopharma demand should start settling down. Hospital budgets are hopefully starting to bottom but we don't know that. So we'll have to see what happens with elective procedures. But overall, I would say there is improvement from a first half to second half in the market in general in Health Care that we have embedded into our guide. On the other hand, the thing we are watching also is oral care, Nicole, or orthodontics. Because as you know, if the economy slows down, that's an area that people will control their spending on. And so that's the other thing we're watching and, of course, China and seeing how the recovery in China plays itself out. But as I mentioned in my prepared remarks, Mike has said it multiple times too, this is a great business. In the long term, this will continue to have very good growth. We are working through some comps from last year which was COVID as well as capital budgets and hospitals. But all those trends in the long term will turn themselves around.

Can we clarify the adjusted sales numbers? It seems your guidance suggests approximately $7.9 billion in sales, which would be a slight decrease from the third quarter in absolute terms. Is that correct?

It's $8 billion.

No, Q4, Q4, Q4. What's implied?

Yes.

Okay. And can you just give us an idea of the range of the absolute margin? I mean we could probably do a lot of backing into it but what you now expect for the year from just a range on an absolute margin basis?

Between 19.5% to 20%, Steve, versus the 19% that we had told you coming into the year.

That's great. Can you explain the shift in approach regarding these liabilities? Specifically, what prompted the transition from a firm stance on how the science influenced your perspective to now accepting a significant charge of $10 billion to $12 billion? That seems like a notable change in mindset.

Yes, addressing litigation, our strategy remains independent of the share price movements. There is certainly an impact on the stock price due to the uncertainty involved. We are focused on doing what we can to tackle litigation and help alleviate that uncertainty. This has been a topic of discussion with investors for several years, and it does factor into our approach. We are not pleased with the stock's overhang, and we aim to manage it. However, as we progress, we need to prioritize what is in the best interest of the company for the long term. Therefore, we will defend ourselves in court and work towards appropriate resolutions.

This is Dan Rizzo for Laurence. Just a quick question on inventories that you've managed so well. How should we think about inventory turnover in the long run, I mean, over the next few years? What is kind of the go-forward thought process?

Yes. As I mentioned earlier, as supply chains start to improve, one of our significant opportunities to keep driving cash flow is through managing inventories. The teams have done an excellent job of leveraging data and analytics. We are enhancing our demand planning capabilities. I believe that in the long run, you should see continued improvements in inventory turnover. As supply chains recover and our demand planning becomes more effective, you can expect to see positive changes over time.

To wrap up, we continue to execute in a dynamic environment. While we see progress and positive momentum, we have more work to do. And we'll continue to advance our restructuring actions, control costs, strengthen our supply chain. At the same time, we will drive our strategic priorities, improving operational execution, successfully spinning off our Health Care business and addressing litigation. I thank 3Mers for their contributions and commitment, especially as we continue to lead through significant chain. We will stay focused on driving growth, improving operational performance, and delivering value to customers and shareholders. Thank you for joining us.