Monish Patolawala
Chief Financial and Transformation Officer at 3M
Thank you, Kevin, and I wish you all a very good morning. Please turn to Slide 6. Our second quarter performance was driven by continued focus on serving our customers, improving manufacturing and supply chain productivity while also maintaining strong spending discipline. Also, during the quarter, we initiated a large part of our restructuring program to simplify and streamline the organization. We are aggressively reducing management layers and rooftops while also streamlining our go-to-market models and supply chain, bringing us closer to our customers.
End-market trends continue to play out as anticipated with ongoing weakness in electronics, soft discretionary spending patterns in consumer retail and mixed trends in industrial end markets. Regionally, China's recovery has been slow, impacted by electronics and soft export trends. Europe remains challenged as the uncertain geopolitical situation persists, while end markets in the U.S. largely remain steady.
Second quarter total adjusted sales were $8 billion or down 4.7% year-on-year. This result was a little better than forecasted as we experienced a smaller-than-anticipated headwind from foreign currency translation of minus 0.9% versus a forecast of minus 2%. On an adjusted basis, organic sales declined 2.5% versus last year. This result included an expected year-on-year headwind of approximately $140 million or 1.7 percentage points related to lower disposable respirator demand. Excluding this impact, Q2 adjusted organic sales declined 0.8%.
On an adjusted basis, second quarter operating income was $1.5 billion with operating margins of 19.3% and earnings of $2.17 per share. These results included pretax restructuring charges of $212 million, which negatively impacted adjusted operating margins by 2.7 percentage points and earnings by $0.31 per share. Without the impact of restructuring, second quarter adjusted operating margins were 22% or up 40 basis points versus last year, and earnings were $2.48, up $0.03 year-on-year.
Turning to other components that impacted results year-on-year. We were able to more than offset the impact of lower sales volumes and inflation impacts through improved manufacturing productivity, benefits from restructuring, strong spending discipline and selling prices while continuing to invest in the business. The net result was an increase to margins of 1.4 percentage points and $0.15 to earnings.
The previously mentioned headwind from disposable respirators resulted in a negative impact to operating margins of 50 basis points and to earnings of $0.09 per share. The carryover impact of higher raw material, logistics and energy cost inflation created a year-on-year headwind of approximately $30 million or a negative 30 basis points impact to operating margins and $0.04 to earnings. As mentioned, foreign currency translation was a negative 0.9% impact to total sales. This resulted in a headwind of 20 basis points to margins and $0.02 to earnings per share.
Divestitures, primarily Food Safety, did not impact margins but resulted in a year-on-year headwind of $0.03 to earnings per share. Finally, other financial items increased earnings by a net $0.06 per share year-on-year primarily driven by a lower share count, which was partially offset by a lower non-op pension benefit.
In summary, our team's focus on driving productivity, executing restructuring actions and controlling spending is starting to yield results. These actions, coupled with improvement in global supply chains, drove sequential improvement in adjusted operating margins across all of our business groups. Excluding restructuring charges, adjusted operating margins improved 3.6 percentage points sequentially.
Please turn to Slide 7. Second quarter adjusted free cash flow was approximately $1.5 billion, up 44% year-on-year with conversion of 122%, up 50 percentage points versus last year's Q2. This year-on-year improvement was driven by our ongoing focus on working capital management, especially inventory, and the timing impact related to restructuring charges. Inventory was flat sequentially versus a typical historical build from Q1 to Q2. We continue to adjust production output to end markets and leverage the power of daily management and data and data analytics to increase the velocity of inventory turns.
Adjusted capital expenditures were $328 million in the quarter or similar year-on-year as we continue to invest in growth, productivity and sustainability. During the quarter, we returned $828 million to shareholders via dividend. Net debt at the end of Q2 stood at $11.7 billion or down 12% year-on-year.
Our business segments continue their long history of robust cash flow generation. In addition, our proven access to capital markets, along with the anticipated onetime dividend from the spin of Health Care at 3 times to 3.5 times EBITDA and 19.9% retained stake, will provide additional financial flexibility. This, combined with our existing strong capital structure, provides us the flexibility to continue to invest in the business, return capital to shareholders and meet the cash flow needs related to ongoing legal matters.
Now please turn to Slide 9 for our business group performance. Starting with our Safety and Industrial business, which posted sales of $2.8 billion or down 4.6% organically. This result included a year-on-year headwind of approximately $140 million or 4.8 percentage points due to last year's COVID-related disposable respirator decline. Excluding disposable respirators, Safety and Industrial sales grew 0.2% organically in Q2.
Organic growth was led by mid-single-digit increases in roofing granules and automotive aftermarket, while personal safety declined due to last year's disposable respirator comp. Excluding disposable respirators, personal safety was up high single digits organically.
Closure and masking declined due to slowdown in packaging and shipping activity, while industrial adhesives and tapes continue to be impacted by end-market softness in electronics. Adjusted operating income was $614 million or down 2.4% versus last year. Adjusted operating margins were 22.2%, up 70 basis points year-on-year and up 2 percentage points sequentially. The year-on-year improvement in margins was driven by productivity actions, strong spending discipline and price. Partially offsetting these benefits were headwinds from lower sales volume, restructuring costs and inflation impacts.
Moving to Transportation and Electronics on Slide 10, which posted Q2 adjusted sales of $1.9 billion. Adjusted organic growth declined 2.4% year-on-year, largely due to the continued decline in demand for electronics. Our auto OEM business increased approximately 21% year-on-year, approximately 600 basis points higher than global car and light truck builds. Our electronics business continues to be impacted by soft end-market demand for electronics. As a result, this business experienced a year-on-year decline in adjusted organic sales of approximately 22%. Electronic end markets continue to remain highly uncertain. We expect our year-on-year organic growth rates in electronics to remain negative in the second half, however, improve versus down nearly 30% in the first half as we start to lap easier comps.
Turning to the rest of Transportation and Electronics. Transportation safety grew high single digits organically, while commercial solutions and advanced materials were up low single digits year-on-year. Transportation and Electronics delivered $369 million in adjusted operating income, down 19% year-on-year. Adjusted operating margins were 19.8%, down 3.6 percentage points year-on-year, however, increased 3.1 percentage points sequentially. Margin headwinds were driven by sales volume declines, restructuring costs and inflation impacts. These headwinds were partially offset by benefits from strong spending discipline, productivity actions and pricing.
Looking at our Health Care business on Slide 11. Q2 sales were $2.1 billion with organic growth up slightly versus last year. Organic sales in oral care were up low single digits year-on-year, and Medical Solutions business grew slightly. Separation and purification and Health Information Systems declined mid-single digits and low single digits, respectively. These businesses continue to be impacted by lower post-COVID-related biopharma demand and ongoing stress on hospital budgets. As procedure volumes continue to improve, hospital budgets stabilize and we work through post-COVID-related impacts, we are confident in the long-term outlook of this business. Health Care's second quarter operating income was $411 million, down 16% year-on-year. Operating margins were 19.8%, down 2.8 percentage points year-on-year, however, increased sequentially 1.9 percentage points. Year-on-year operating margins were impacted by lower sales volume, restructuring costs and inflation impacts. These headwinds were partially offset by benefits from strong spending discipline, productivity actions and pricing.
Finally, on Slide 12. Our Consumer business posted second quarter sales of $1.3 billion. Organic sales declined 2.2% year-on-year as discretionary spending on hardline categories remains soft. We expect this trend to continue into the second half of the year. Organic sales grew slightly in home, health and auto care, while home improvement and stationery and office businesses both declined. Consumer second quarter operating income was $235 million, down 5% compared to last year, with operating margins of 18.2%, down 40 basis points year-on-year but up 3.2 percentage points sequentially. The year-on-year decline in operating margins was driven by lower sales volumes, restructuring costs and inflation impacts. These headwinds were partially offset by benefits from strong spending discipline, productivity actions and pricing.
That concludes our remarks on the second quarter. Please turn to Slide 14 for an update on our full year expectations. During our January earnings call, we highlighted that we expected macroeconomic and end-market uncertainties to continue to persist into the year. In addition, we noted that we were starting to see the healing of supply chains. However, we expected to continue to see headwinds from raw material availability and inflation, although at a lower level than 2022.
We also stated that we were not satisfied with our performance and we would be taking a deeper look at everything we do as we continue to prepare for the spin of Health Care. As a result, we noted that as we move through the year, we would be taking additional actions to improve supply chain performance, drive simplification and bring us closer to our customers.
While we have more work to do, let me take a moment to provide a few examples on the progress we have made through the first half of the year. Starting with our sales performance. While end markets continue to play out as expected, Q1 and Q2 revenue was slightly above our expectations. Our teams continue to relentlessly focus on serving our customers, work down backlogs and leverage the use of data and data analytics to drive improvements in demand planning.
Next, as we have mentioned, we are aggressively addressing structure. We are on track with our actions to reduce structure across the company, including at corporate, in our business segments and in manufacturing supply chain. We have initiated the transition of 24 countries to an export model, partnering with local distribution to serve those customers and markets.
In addition, we have made good progress in reducing corporate structure, including the exit of our aviation operations and our conference center in Northern Minnesota. And finally, we continue to adjust our production levels to end-market trends, manage inventory and aggressively control spending.
As a result of our actions, along with improvements in global supply chains and raw material availability, we are able to deliver first half performance better than anticipated, particularly for margins, earnings and cash flow.
In the first half of the year, on an adjusted basis, we delivered 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 or a headwind to margins of 1.7 percentage points and to earnings of $0.38 per share. In addition, our strong operational execution and working capital management, particularly inventories, helped us to deliver $2.3 billion of adjusted free cash flow with a conversion rate of 105%.
Turning to guidance. We are raising our full year adjusted earnings expectation as a result of our strong first half operational execution as evidenced by an improving margin rate. We now expect full year's earnings in the range of $8.60 to $9.10 versus a prior range of $8.50 to $9.
We continue to closely monitor end-market trends across all our businesses, particularly in electronics, consumer retail, industrial and China and have yet to see signs of improvement in trends. Therefore, we currently see organic growth tracking to the lower end of our range of flat to minus 3%. This reflects our performance to date along with our year-on-year headwind from disposable respirators tracking to the high end of our anticipated range or down approximately $550 million along with continued macro and end-market uncertainty. And finally, our full year adjusted free cash flow conversion expectation remains unchanged in a forecasted range of 90% to 100%.
Looking ahead to the third quarter. We expect end-market trends to be very similar to Q2. Hence, we anticipate third quarter adjusted sales to be approximately $8 billion. The impact from the COVID-related decline in disposable respirators and last year's exit of Russia is anticipated to be a year-on-year headwind to sales of approximately $130 million or 1.5 percentage points.
Third quarter pretax restructuring costs are expected to be in the range of $125 million to $175 million with pretax benefits of $125 million to $150 million. Taken together, we expect third quarter adjusted earnings per share will be in the range of $2.25 to $2.40.
To wrap up, we continue to have a strong focus on serving our customers, improving the execution in our supply chain, making progress in our restructuring actions, managing costs and investing in the business while navigating ongoing end-market weakness. We expect our actions will continue to build momentum and improve our organic growth, margins and cash flow performance into the future.
I want to thank our customers and suppliers for their partnership and the 3M employees for their hard work and dedication as they continue to deliver for our customers and shareholders. I am confident in our future. As we have said, as we exit 2023, we will be a stronger, leaner and more focused 3M.
That concludes my remarks. We will now take your questions.
