Monish Patolawala
Executive Vice President, Chief Financial and Transformation Officer at 3M
Thank you, Mike, and I wish you all a very good morning. Please turn to Slide 4. Overall, the 3M team delivered third quarter sales and operating margins that were very much in line with my comments at a conference in mid-September with some puts and takes as consumer and consumer electronics demand declined as the quarter progressed while industrial end markets demand remained steady.
Third quarter total sales were $8.6 billion or down 3.6% year-on-year, which included headwinds of 5.1% or $450 million from foreign currency translation and 50 basis points or $50 million from the divestiture of Food Safety, along with the deconsolidation of Aearo Technologies. On an organic basis, third quarter sales increased 2% versus last year. This result includes an anticipated falloff in disposable respirator demand, which negatively impacted organic sales by approximately $130 million or 1.4 percentage points. Excluding this decline, Q3 organic sales growth was 3.4%.
On an adjusted basis, third quarter operating income was $1.9 billion with operating margins of 21.5%, which were up 40 basis points year-on-year and 50 basis points sequentially. Adjusted earnings for the quarter were $2.69 versus $2.58 last year.
Turning to the components that impacted third quarter operating margins and earnings year-on-year performance. As you may recall, during our Investor Day this past February, we laid out our operating framework and operating principles that included daily management, data democratization, transparency and accountability. We continue to make progress on the consistency of application of this framework. By embracing these principles, along with taking self-help actions, the team executed well in the quarter as we continue to navigate the fluid and uncertain macro and geopolitical environment.
We continue to focus on serving our customers and drive additional actions, including: recovering our sales backlog in China from the April and May COVID-related lockdowns; implementing appropriate selling price actions to address ongoing inflation; maintaining strong spending discipline; implementing targeted productivity actions to adjust businesses to end market demand trends while driving simplification; and continuing to invest in growth, productivity and sustainability to ensure we are all well positioned for long-term success. These actions helped to more than offset a number of headwinds in the quarter, including: the decline in disposable respirator sales, which negatively impacted Q3 operating margins by 30 basis points and earnings by $0.07 a share; incremental end market softness, particularly in consumer electronics, along with oral care and consumer retail in the U.S. as persistent inflationary pressures are slowing consumer spending; ongoing global supply chain challenges and raw material constraints; and finally, geopolitical impacts, particularly Russia, which was a year-on-year headwind of $50 million to revenue and $0.03 to earnings per share. In total, our operating framework and self-help actions resulted in an overall net benefit to operating margins of 2.9 percentage points and $0.41 to earnings.
Moving to raw material and logistics inflation. As I've noted over last several quarters, inflationary pressures remain persistent and are broad-based. Therefore, we continue to experience year-on-year headwinds with a Q3 cost increase of approximately $225 million or a negative impact of 2.6 percentage points to operating margins and $0.31 to earnings. Our full year raw materials and logistics inflation estimate of $750 million to $850 million remains unchanged. And as we have said before, we continue to expect to offset this through pricing actions.
The strength of the U.S. dollar continued to affect total revenue as foreign currency translation was a negative 5% impact. As a result, we had a benefit of 10 basis points to margins, however, incurred a headwind of $0.12 to earnings per share.
As Mike mentioned, we have been actively managing our portfolio. On September 1, we closed the Food Safety divestiture, resulting in approximately $1 billion in consideration received along with reducing outstanding share count by 16 million via an exchange offer. However, we lost one month of sales and income from Food Safety in the quarter. Therefore, the lost sales and income from Food Safety, along with the deconsolidation of Aearo Technologies, resulted in a year-on-year headwind of $0.02 to earnings per share in the quarter.
Finally, other financial items increased earnings by net $0.15 per share year-on-year driven equally by benefits from a lower share count along with a lower-than-expected tax rate. The lower third quarter adjusted tax rate was primarily the result of favorable outcomes from prior year audit settlements and geographic income mix. Looking at the full year, we now expect our adjusted tax rate in the range of 17.5% to 18.5% versus 18.5% to 19.5% previously.
Please turn to Slide 5. Third quarter adjusted free cash flow was $1.4 billion with conversion of 88%, an improvement from first half performance as we drive working capital intensity, including improved inventory levels, while also increasing capex for growth and sustainability investments.
We remain focused on working capital improvement as we continue to navigate through a fluid supply chain environment. Even though the environment remains challenging, we are realizing benefits from our efforts as we leverage the use of data and data analytics to reduce inventory levels through better demand planning and optimized customer payment terms. We expect to continue to realize benefits from our actions as we move forward.
Capital expenditures were $435 million in the quarter and $1.2 billion year-to-date or up 19% year-on-year as we continue to invest in growth, productivity and sustainability. Based upon the current status of supply chains and pace of projects, we now expect full year capex investments in the range of $1.75 billion to $1.85 billion.
During the quarter, we returned $1 billion to shareholders through the combination of cash dividends of $850 million and share repurchases of $155 million. On a year-to-date basis, we returned $3.5 billion to shareholders, including $2.6 billion in dividends and $900 million in share repurchases. In addition, we reduced our outstanding share count by 16 million via an exchange offer associated with the Food Safety divestiture.
Both dividends and share repurchases remain important pillars of our capital allocation strategy. We continue to see the current value of the stock as a very attractive opportunity and have resumed share repurchase activity following the Food Safety divestiture.
Having a strong balance sheet and capital structure remains a priority for 3M because of the flexibility it provides us to continue to invest organically in the business, pursue strategic M&A opportunities and return cash to shareholders while navigating legal matters. Net debt at the end of Q3 stood at $12.1 billion, down 3% year-on-year and down over 30% since 2019.
Please turn to Slide 7 for our business group performance for Q3. I will start with our Safety and Industrial business, which posted sales of $2.9 billion or up 1.7% organically compared to last year's third quarter. This result included a year-on-year headwind of approximately $130 million due to the ongoing decline in demand for disposable respirators. Excluding disposable respirators, Safety and Industrial posted Q3 organic growth of over 6%, driven by broad-based performance along with the backlog recovery in China from the April and May COVID-related lockdowns. Our personal safety business declined low double digits organically primarily due to the decline in COVID-related disposable respirator demand.
Turning to the rest of Safety and Industrial. Organic growth was led by low teen increases in both automotive aftermarket and roofing granules. Electrical markets and abrasives grew high single digits, while closure and masking systems and industrial adhesives and tapes delivered mid-single-digit growth. Operationally, the Safety and Industrial team drove strong execution during the third quarter, delivering adjusted operating income of $673 million, up 8% versus last year and up 7% sequentially versus Q2. Adjusted operating margins were 23.2%, up 2.5 percentage points as the team managed inflation with price actions, drove yield and efficiency and exercised strong spending discipline.
The Safety and Industrial Business Group continues to focus on investing for the future, including in digital platforms such as repair stack for connected automotive body shops and sustainable platforms like thermal barriers for auto electrification.
Moving to Transportation and Electronics, which posted sales of $2.2 billion or up 3% organically compared to last year. Overall growth was benefited by COVID-related backlog recovery in the Greater China region, which was partially offset by increased weakness in consumer electronics demand, along with the continued constraints in the semiconductor supply chain. Our electronics-related business declined mid-single digits organically with decreases across consumer electronics, particularly smartphones, tablets and TVs. These declines were partially offset by continued strong demand for our solutions in semiconductor, factory automation and automotive end markets.
Organic sales in our auto OEM business were up 21% year-on-year as compared to an estimated 27% increase in car and light truck builds. As you may recall, we outperformed last year's Q3 build rate by nearly 20 percentage points as we benefit from a channel inventory build, which was unwound in Q4 last year.
Turning to the rest of Transportation and Electronics. Commercial solutions grew organically high single digits, while advanced materials grew mid-single digits and transportation safety was down low single digits. Despite the continued fluid end market environment, the Transportation and Electronics team delivered strong operating performance. Third quarter operating income increased 9% to $474 million with operating margins of 21.2%, up 2.5 percentage points year-on-year. Operating margins were benefited by price actions as we navigated inflationary pressures along with the strong spending discipline.
The Transportation and Electronics business group is investing to solve some of the toughest challenges in the market and executing for future growth. For example, in Q3, we opened a new battery component testing lab to support accelerating opportunities in automotive electrification.
Looking at our Health Care business, which delivered Q3 sales of $2.1 billion with organic growth of 1.7% versus last year's strong 8% comparison. Our medical solutions, food safety, separation and purification and Health Information Systems businesses all increased low single digits organically. While we did have organic growth in separation and purification year-on-year, biopharma was down in the U.S. due to last year's strong demand for COVID therapeutics.
Third quarter elective medical procedure volumes were approximately 90% of pre-COVID levels as we saw activity dip in July and ramp back up as we went through the quarter. Fourth quarter procedure volumes are currently projected to be 90% to 95% of pre-COVID levels as labor shortages continue to impact the pace of recovery.
Oral care was down mid-single digits against low double-digit growth from a year ago. We are also seeing softening due to the ongoing inflationary pressures impacting consumer spending on discretionary oral care and orthodontic procedures.
Health Care's third quarter operating income was $452 million, down 11% year-on-year. Operating margins were 21.8%, down 1.7 percentage points with adjusted EBITDA margins of over 29%. Year-on-year operating margins were impacted by increased raw materials and logistics costs along with manufacturing productivity headwinds. These impacts were partially offset by price actions and spending discipline.
The Health Care Business Group is focused on delivering innovation, including investments in the launch of 3M Filtek Matrix, which creates a new and innovative approach for dental restorations, simplifying the procedure and enabling more natural tooth structure to remain. In addition, the team made capital investments to support manufacturing capacity expansions in the separation and purification and Medical Solutions business.
Lastly, our Consumer business posted third quarter sales of $1.4 billion or up 1.5% year-on-year on an organic basis versus last year's 8% comparison. Year-on-year growth in the third quarter was led by consumer health and safety, which was up mid-single digits organically, and stationery and office and home care, which both grew low single digits.
Home improvement growth was down low single digits organically versus last year's strong comparison, however, increased mid-teens sequentially. The back-to-school season was softer than expected as consumer spending continues to be impacted by ongoing inflationary pressures, along with retailers aggressively addressing elevated inventory levels. Looking ahead, we anticipate these impacts to continue throughout the upcoming holiday season.
Consumer's third quarter operating income was $299 million, down 3% compared to last year, with operating margins of 21.3%, down slightly year-on-year. Our Consumer business operating margins benefited from selling price actions, spending discipline and restructuring actions. These benefits were more than offset by increase in raw materials, logistics and outsourced hard goods manufacturing costs and manufacturing productivity headwinds. The Consumer Business Group is executing for future growth, including expanding our Command platform to help consumers hang, organize and decorate in even more creative ways.
Please turn to Slide 9 for a discussion on our 2022 outlook. The macro environment remains uncertain with mixed trends and signals across geographies and end markets. While we are working through these challenges and taking actions, we are updating our full year guidance, reflecting our year-to-date performance, increasing U.S. dollar strength, along with the continued fluid environment.
Our updated 2022 full year outlook includes: organic growth in the range of 1.5% to 2% versus a prior range of 1.5% to 3.5%; adjusted earnings in the range of $10.10 to $10.35 versus a prior range of $10.30 to $10.80, which includes an additional headwind of $0.15 per share from foreign currency exchange compared to just three months ago; and adjusted free cash flow conversion to be in the range of 85% to 95% versus a prior range of 90% to 100%.
Before I wrap up, let me make a few comments regarding the fourth quarter. First, from an end market perspective, GDP and IPI continued to moderate with current Q4 estimates of 1.4% and 2.2%, respectively. We are closely monitoring the geopolitical environment in Europe and the impact on energy inflation and end market demand. Auto build rates are currently estimated to be up 2% year-on-year, while consumer electronics demand is expected to remain soft. Health care elective procedure and oral care volumes are expected to be in the range of 90% to 95% of pre-COVID levels. And lastly, we anticipate continued inflationary impacts on consumer spending, along with the inventory reduction actions at retailers. Therefore, looking at the fourth quarter, we expect total sales to be in the range of $7.9 billion to $8.2 billion. This includes organic growth in the range of 1% to 3%, which includes a 2% headwind or $150 million to $200 million from the continued decline in disposable respirator demand; and the exit of Russia, which will create a year-on-year headwind of approximately 80 basis points or approximately $70 million. Excluding the impact from these two items, Q4 organic growth is estimated to be nearly 4% to 6%.
Increasing U.S. dollar strength is anticipated to be a year-on-year headwind of approximately 7% of sales or roughly $600 million. The divestiture of Food Safety and deconsolidation of Aearo Technologies will result in a Q4 headwind of approximately $120 million to sales or 1.5%.
Turning to raw materials and logistics costs. We anticipate a Q4 year-on-year headwind of approximately $100 million to $150 million, which we expect to able to navigate and offset the price actions. Operating margins are expected to be in the range of 20% to 21%. And finally, our outstanding share count is currently anticipated to be in the mid-550 million share range, taking into account the 16 million share count reduction that I mentioned earlier.
Looking ahead to 2023. While we are in the early stages of working through our plan, we see some items impacting us this year that will continue into next year while some challenges may ease. We expect the macroeconomic environment to continue to moderate while geopolitical uncertainties persist, impacting energy costs and end market demand, particularly in Europe. We are also monitoring the impact of the strong U.S. dollar along with evolving COVID-related impacts, including on government policy response, health care elective procedure volumes and disposable respirator demand.
Looking at end markets. We expect the pace of secular industry trends to accelerate, particular in automotive, electronics, safety, digitization and sustainability. Each of these markets have tremendous opportunities for long-term growth as we continue to innovate and invest in these areas.
Raw material, logistics and labor inflation are starting to show some signs of moderation, and we are starting to see some evidence of global supply chain stabilization. As Mike mentioned, we believe manufacturing and supply chain operations are our greatest opportunity to reduce costs and increase productivity to drive improvement in operating margin performance.
While significant uncertainty is expected to remain, we are focused on serving customers and executing our operating framework and operating principles. We are prepared and will adjust as warranted and take necessary self-help actions to deliver long-term value for all our stakeholders. And finally, we are also working on ensuring we execute well on our Health Care spin to create two leading, world-class companies. As always, there is more we can do and will do.
To wrap up, I want to thank our customers and suppliers for their partnerships and the 3M employees for their hard work and dedication as they continue delivering for our customers.
That concludes my remarks for the third quarter. With that, we will now take your questions.