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 5. As Mike mentioned, the first quarter macro and end-market trends have played out largely as anticipated. We experienced significant end-market weakness in consumer electronics, shifting consumer spending patterns along with the retailer destocking and mixed industrial end-markets. We also continue to navigate COVID-related impacts in China and the ongoing geopolitical challenges in Europe.
Given the expected challenging start to the year, we relentlessly focused on serving our customers and took very aggressive actions to manage costs and spending. These actions, coupled with the lower-than-expected foreign currency headwind, enabled us to deliver a first quarter that was better than forecasted.
First quarter total adjusted sales was $7.7 billion, or down 9.7% year-on year. In addition to focusing on serving customers, first quarter sales benefited from a smaller than anticipated headwind to sales from foreign currency translation. The first quarter year-on-year translation impact was a minus 2.8% or approximately $230 million versus a forecast of minus 3% to minus 4%. We also experienced a 1.3% sales decline from divestitures or approximately $120 million versus Q1 last year. This decline was largely from the third quarter 2022 divestiture of Food Safety along with the deconsolidation of Aearo Technologies.
On an adjusted organic basis, first quarter sales decreased 5.6% versus last year. This result included an expected year-on-year headwind of approximately $300 million, or 3.4 percentage points related to lower disposable respirator demand and the exit of our operations in Russia last year in the third quarter. Excluding this decline, Q1 adjusted organic sales growth was minus 2.2%. First quarter adjusted operating income was $1.4 billion with operating margins of 17.9% and adjusted earnings of $1.97.
Turning to the components that impacted first quarter operating margins and earnings year-on-year performance. Our Q1 margin and earnings reflect the previously mentioned lower sales volume. This lower sales volume combined with our efforts to reduce inventories resulted in lower manufacturing productivity versus last year's first quarter. We were able to partially offset these headwinds through pricing performance and aggressive cost management, resulting in a net headwind to margins of 90 basis points and $0.17 to earnings.
As mentioned, we faced a challenging Q1 comp from last year's Omicron-driven disposable respirator demand along with the exit of operations in Russia. This sales comp headwind resulted in a negative impact to operating margins of 1.1 percentage points and to earnings of $0.21 per share. We continued our focus on improving our manufacturing and supply chain operations, including executing on restructuring actions to streamline the organization and adjust to slowing end-market demand.
Restructuring charges in the quarter were $52 million, or a year-on-year headwind of 50 basis points to margin and $0.05 to earnings per share. The carryover impact of higher raw material, logistics and energy cost inflation created a year-on-year headwind of approximately $100 million or a negative 130-basis-point impact to operating margins and $0.15 to earnings.
As mentioned, foreign currency translation was a negative 2.8% impact to total sales. This resulted in a headwind of 30 basis points to margins and $0.10 to earnings per share. Divestitures, primarily Food Safety along with the deconsolidation of Aearo Technologies resulted in a year-on-year headwind of $0.03 to earnings per share in the quarter. Finally, other financial items increased earnings by a net $0.05 per share year-on year driven by lower share count, partially offset by higher non-op pension expense.
Please turn to Slide 6. First quarter adjusted free cash flow was approximately $950 million, up 24% year-on-year, with conversion of 87%, up 37 percentage points versus last year's Q1. This year-on-year improvement was driven by lower annual incentive cash compensation and a strong focus on working capital management, particularly inventory improvement.
During the quarter, we continue to address manufacturing production levels to better align with end-market trends. Since last August, we have driven an approximately $500 million reduction in inventory levels. As I've said before, as supply chains heal and we progress the use of data and data analytics, we will see a reduction in inventory levels.
Adjusted capital expenditures were $445 million in the quarter, up 15% year-on-year as we continue to invest in growth, productivity and sustainability. During the quarter, we returned nearly $900 million to shareholders. Net debt at the end of Q1 stood at $12 billion, down 10% year-on year with net debt to EBITDA at 1.5 times.
Please turn to Slide 8 for our business group performance. I will start with our Safety & Industrial business, which posted sales of $2.8 billion, or down 6% organically. This result included a year-on-year comp headwind of $285 million due to last year's Omicron-driven disposable respirator demand and exit of Russia. Excluding the impact from disposable respirators and Russia exit, Safety & Industrial sales grew nearly 4% organically in Q1. Organic growth was led by high-single-digit increases in automotive aftermarket, electrical markets and abrasives, while the personal safety business declined mid-teens, primarily due to the decline in disposable respirator demand. Excluding the impact from disposable respirators, the personal safety business grew low double digits organically.
Turning to the rest of Safety & Industrial. Organic growth declined high-single-digits in industrial adhesives and tapes due to consumer electronics softness and closure and masking systems was down low-single digits as consumers pull-back on discretionary spending impacting e-commerce shipments. Roofing granules were down low-single digits.
Adjusted operating income was $562 million, or down 19% versus last year. Adjusted operating margins were 20.2%, down 2.4 percentage points year-on-year. Margin headwinds were driven by lower sales volume, manufacturing and supply-chain headwinds, carryover raw-material logistics and energy cost inflation, investments in the business and impacts from China COVID-related challenges. These headwinds were partially offset by benefits from pricing, aggressive spending discipline and productivity actions.
Moving to Transportation & Electronics on Slide 9, which posted Q1 adjusted sales of $1.7 billion. Adjusted organic growth declined 11.3% year-on year heavily impacted by a significant decline in demand for consumer electronic devices. Our auto OEM business increased approximately 6% year-on-year in-line with global car and light truck builds. We continue to gain penetration on new automotive platforms and expect to outperform build rates over the long run.
Our Electronics' business saw adjusted organic sales declines in the mid 30% range. This business continues to be impacted by significant end-market weakness along with Tiers and OEMs aggressively reducing inventories, particularly for smartphones, tablets and TVs.
Turning to the rest of Transportation & Electronics, advanced Materials had adjusted organic growth of high-single-digits year-on-year, while both transportation safety and commercial solutions declined. Transportation & Electronics delivered $284 million in adjusted operating income, down 36% year-on-year. Adjusted operating margins were 16.7%, down 5.5 percentage points year-on-year.
Margin headwinds were driven by sales volume declines, manufacturing and supply chain headwinds, carryover raw material logistics and energy cost inflation, investments in the business and impacts from China COVID-related challenges. These headwinds were partially offset by benefits from pricing, aggressive spending discipline and productivity actions.
Looking at our Health Care business on Slide 10. Q1 sales were $2 billion with organic growth of 1.4% versus last year. Excluding the impact from the exit of Russia, Health Care grew Q1 organic sales by approximately 2%. Sales in our Medical Solutions business and Oral Care grew low-single digits organically year-on year, while Health Information Systems was flat due to strained hospital budgets. Separation and purification declined high-single-digits due to the normalization of post-COVID related Biopharma demand. First quarter elective healthcare procedure volumes were approximately 90% of pre-COVID levels as nurse labor shortages and strained hospital budgets continue to impact the pace of recovery. We continue to expect procedure volumes to improve as we progress through the year.
Health Care's first quarter operating income was $360 million, down 19% year-on year. Operating margins were 17.9%, down 3 percentage points. Year-on-year operating margins were impacted by manufacturing and supply chain headwinds, carryover raw material logistics and energy cost inflation and investments in the business. These headwinds were partially offset by benefits from pricing, aggressive spending discipline and productivity actions.
Lastly, on Slide 11, our Consumer business posted first quarter sales of $1.2 billion. Organic sales declined 6.8% year-on-year with particular weakness in the U.S., which was down high-single-digits. Stationery and office grew low-single digits organically year-on-year, while the home improvement and home health and auto care business declined organically. Relative to first quarter last year, consumers have shifted their spending patterns to more non-discretionary items and retailers have aggressively reduced their inventory levels. We expect consumers to remain cautious with their discretionary spending as we move forward through the year.
Consumers first quarter operating income was $179 million, down 18% compared to last year with operating margins of 15%, down 1.8 percentage points year-on-year. The year-on-year decline in operating margins was driven by lower sales volume, manufacturing and supply-chain headwinds and carryover raw material, logistics and energy cost inflation. These headwinds were partially offset by benefits from pricing, aggressive spending discipline and productivity actions.
That concludes our remarks on the first quarter. Please turn to Slide 13 for a discussion on our outlook for the year and the second quarter. We are maintaining our full year guidance reflecting a macroeconomic and end-market environment that remains very fluid and uncertain. Our outlook continues to incorporate the expected second half improvement in macroeconomic forecasts, including in China. We also anticipate that continued healing of global supply chains, which will help support ongoing product cost improvements in our manufacturing and supply chain operations along with working capital performance, particularly inventory reductions.
As a reminder, our full year adjusted organic sales growth is expected to be in the range of minus 3% to flat. This range includes an estimated 2 percentage point headwind from the ongoing decline in disposable respirator demand along with the impact of our exit from Russia. Adjusted earnings are expected to be in the range of $8.50 to $9 per share. Full year adjusted free cash flow conversion remains forecasted in the range of 90% to a 100%.
Turning to our outlook for the second quarter. First, looking at external macroeconomic forecasts, both global GDP and IPI are currently expected to improve year-on-year and sequentially. The softness we experienced in Q1 in consumer electronics and consumer retail is expected to continue into Q2. We expect both sequential and year-on-year increase in auto builds, while healthcare procedure volumes are anticipated to be similar to Q1 levels and industrial end-markets are expected to remain mixed.
As discussed, we implemented very aggressive cost controls in the first quarter given the challenging start to the year, including on travel, advertising, external services and headcount management. While we will remain disciplined, we expect to increase investments as we progress through the year to support end-market demand improvement in the second half and into the future. Including these factors, our expectations for Q2 are for total adjusted sales to be in the range of $7.7 billion to $7.9 billion versus $8.4 billion last year or down 6% to 8% year-on-year.
Organic sales is expected to be down low-to mid-single-digits, which includes the forecasted year-on-year headwind of approximately 1.5% from disposable respirators. And finally, foreign currency translation is expected to be approximately a minus 2% headwind to sales versus last year's Q2 and divestitures a year-on-year headwind of minus 1%.
From an EPS perspective, we estimate that second quarter adjusted earnings per share will be in the range of $1.50 to $1.75 including a pretax restructuring charge of $175 million to $250 million or $0.25 to $0.35 per share. This range also incorporates the continued softness in organic sales, an expected increase in investments, higher non-op interest costs and an adjusted tax rate of 18.5% to 19.5%.
To wrap-up, 2023 is a pivotal year for 3M from an execution perspective. As I mentioned, we aggressively managed cost focused on serving customers, while navigating end-market weakness particularly in consumer-facing markets as we started the year. We expect organic sales volumes will improve as consumer retail and consumer electronics market stabilize, China work-through its COVID-related challenges as our year-on year comps ease. The actions we announced today will enable us to exit 2023 stronger than we started and provide for significant margin and cash flow improvement into the future.
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. We will now take your questions.
