Ladies and gentlemen, thank you for standing by. Welcome to the 3 ms Second Quarter Earnings Conference Call. During the presentation, all participants will be in a listen only mode. Afterwards, we'll conduct a question and answer session. As a reminder, this call is being recorded Tuesday, July 26, 2016.
I would now like to turn the call over to Bruce Jermeland, Director of Investor Relations at 3 ms.
Thank you, and good morning, everyone. Welcome to our Q2 2016 business review. On the call today are Inge Tuleen, 3 ms's Chairman, President and CEO and Nick Gangstedt, our Chief Financial Officer. Each will make some formal comments, and then we'll take your questions. As a reminder, please mark your calendars for upcoming earnings call dates, October 25 January 24.
Also take note of our next investor meeting scheduled for December 13. More details will be available as we get closer to that date. Today's earnings release and slide presentation accompanying this call are posted on our Investor Relations website at 3m.com. Please take a moment to read the forward looking statement on Slide 2. During today's conference call, we will make certain predictive statements that reflect our current views about Trem'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 ks lists some of the most important risk factors that could cause actual results to differ from our predictions. Please turn to Slide 3, and I'll hand it off to Inge.
Thank you, Bruce. Good morning, everyone, and thank you for joining us. We delivered another strong performance in the 2nd quarter, marked by our highest quarterly earnings per share in 3 ms history, driven by increased margins. At the same time, we were active in deploying capital to both invest in the long term success of our enterprise and return cash to our shareholders. Looking at the numbers, earnings were $2.08 per share, up 3% year over year.
Organic sales were down slightly at minus 20 basis points. Our 2 domestic driven businesses once again paced our company's organic growth in the quarter. Healthcare posted 5% growth with positive growth in all businesses and geographic areas, and consumer grew 3%, driven by strong performance in our command, field treat and post it products. Safety and Graphics also delivered solid growth, while Industrial was down slight low single digits. Organic growth in electronics and energy declined in the high single digits as we communicated during the Q2.
That business continues to be impacted by weaker demand and elevated channel inventories in the consumer electronics markets. Acquisitions net of divestitures added more than 1 percentage point to our sales, while the strong U. S. Dollar reduced sales by a similar amount. As a result, we delivered total sales of $7,700,000,000 in the quarter.
In a global environment that remains uncertain, our team continues to focus on driving efficient growth and premium returns. In the Q2, we delivered healthy margins of 24.4%, up 50 basis points year over year. 4 of our 5 business groups posted margins above 23%, including Healthcare at 33% and Safety and Graphics at 27%, demonstrating the breadth of our strength. Our ability to generate premium returns along with strong free cash flow enable us to consistently invest in the business, while also return cash to our shareholders. In the Q2, we invested 10% of sales into the combination of research and development and capital expenditure, which is important to our business model and those are our foundation for the future.
Also, with an eye on the future, we continue to make good progress on business transformation, which is one of our 3 key levers. At our Investor Day in March, you heard me talk about customer first, an initiative that is ingrained in everything we do, including business transformation. It is all about making it easier and quicker for our customers to do business with us everywhere around the world. To date, we have deployed our ERP system, which is the backbone of our business transformation in a dozen countries as well as in 4 of our largest European distribution centers. Most recently, in the Q2, we had 2 successful rollouts in West Europe, specifically in our operations in Austria and Switzerland.
We have also expanded the scale and impact of our 3 global service centers located in Costa Rica, Poland and Philippines. Through these centers, we are building a platform for operational efficiencies today and into the future. Business Transformation is strengthening our company. It starts and ends with our customers and has significant long term benefits. We expect to result a $500,000,000 to $700,000,000 in annual operational savings by 2020 and $500,000,000 reduction in working capital.
In summary, we had a good performance in the 2nd quarter in terms of increased margins, strong earnings and investments in the business, while also returning EUR 1,500,000,000 to our shareholders through dividends and share repurchases. With that, I will turn the call over to Nick, who will take you through more of the details. Nick?
Thank you, Inge, and good morning, everyone. I'll start my comments on Slide 4 with a summary of our Q2 sales performance. Organic local currency sales declined 0.2% in the 2nd quarter, with volumes down 1.3% and selling prices up 1.1%. Acquisitions, net of divestitures, added 1.4 percentage points to our sales. This includes the acquisitions of Capital Safety and membrana, net of 3 small divestitures.
Finally, foreign currency translation reduced sales by 1.5%. In dollar terms, worldwide sales declined 0.3% versus the Q2 of 2015. Organic growth in the United States was up 0.4% with solid performances in our domestic oriented businesses, namely Healthcare and Consumer as well as in Safety and Graphics. Similar to Q1, U. S.
Manufacturing activity remained soft in Q2. This, combined with continued weakness in the oil and gas end market, impacted portions of our industrial business. In Asia Pacific, organic growth was down 5.4%. Strong growth from our Healthcare and Consumer businesses was more than offset by a double digit decline in Electronics and Energy as we continue to experience soft end market demand and channel inventory adjustments in consumer electronics. Within Asia Pacific, organic growth was down 1% in Japan and 7% in China, Hong Kong.
Excluding our electronics related businesses, Japan was up 2% and China, Hong Kong down 2%. Moving to EMEA, we posted organic growth of 3% in the quarter, led by West Europe. We delivered growth across all businesses in West Europe. From a country perspective, growth was led by Germany and France. Finally, organic growth in Latin America Canada increased 4.8% with Canada up 6% and Mexico up 5%, while Brazil declined 2%.
Please turn to Slide 5 for the Q2 P and L highlights. 2nd quarter sales were $7,700,000,000 and earnings were $2.08 per share. Operating margins improved by 50 basis points year on year to 24.4%, an all time record margin for the 2nd quarter. The combination of lower raw materials and higher selling prices contributed 130 basis points to our margin improvement, while lower pension and OPEB expense increased margins by another 110 basis points. Productivity gains related to last year's 4th quarter restructuring expanded margins by an additional 40 basis points.
Lower year on year organic volumes, inventory declines and related utilization impacts reduced margins by 110 basis points. The lower utilization was most pronounced in Electronics and to a lesser extent, industrial. Foreign currency translation impacts, net of hedge gains, decreased margins by 30 basis points. Strategic investments also reduced margins by 30 basis points as we accelerated growth investments and took actions to further optimize our manufacturing footprint. As a reminder, we expect the impact of strategic investments to increase in the second half of the year.
Finally, legal and other factors reduced margins by 60 basis points in the quarter, 50 basis points of which related to an unfavorable arbitration ruling on a long standing insurance claim. For reference, our Q2 corporate and unallocated expense was up $47,000,000 sequentially, primarily due to this unfavorable arbitration ruling. For the full year, we expect corporate and unallocated expense to be in the range of $150,000,000 to $200,000,000 Let's now turn to Slide 6 for a look at EPS. We posted earnings of $2.08 per share in the 2nd quarter, up 3% year over year. Margin expansion, net of organic sales declines contributed 0 point 0 $4 to our earnings per share improvement.
1st year acquisitions and divestitures added another $0.03 to earnings, driven by solid performances from both Capital Safety and membrana. Foreign currency impacts, net of hedging, reduced pretax earnings by $40,000,000 or the equivalent of $0.04 a share. The 2nd quarter tax rate was 29.6% versus 28.1% in last year's comparable quarter, which decreased Q2 earnings by 0 point 0 $4 And finally, we reduced average diluted shares outstanding by 3% year on year, which added $0.07 to 2nd quarter EPS. Please turn to Slide 7 for a look at our cash flow performance. Operating cash flow was $1,300,000,000 in the 2nd quarter $2,500,000,000 year to date.
Our strong cash flow enables us to invest in the business and return cash to shareholders. CapEx investments in Q2 totaled $323,000,000 and we continue to expect full year CapEx in the range of $1,300,000,000 to $1,500,000,000 These investments drive organic growth, strengthen our manufacturing technologies and support business transformation. Free cash flow conversion was 75% in the quarter, similar to last year. For the full year, we continue to expect free cash flow conversion in the range of 95% to 105%. In addition to investing in our businesses, we returned significant cash to shareholders, including $672,000,000 in dividends, up $26,000,000 year on year.
We also returned $828,000,000 to shareholders through gross share repurchases. Through the first half of twenty sixteen, we have repurchased $2,100,000,000 of our own shares. We continue to anticipate full year gross share repurchases to be in the range of $4,000,000,000 to $6,000,000,000 Let's now review each of our business groups starting on Slide 8. Our Industrial Business Group posted sales of $2,600,000,000 in the 2nd quarter. Organic growth was down 1.4%, reflecting the continued economic challenges in the global industrial sector.
Positive Q2 growth in Latin America, Canada and EMEA was more than offset by declines in Asia Pacific and the U. S. As mentioned earlier, manufacturing activity in the U. S. Remained soft in Q2, which impacted parts of our industrial business.
Looking across our industrial business group, our automotive OEM business grew high single digits again this quarter and continued to outpace global car and light truck builds. We also posted mid single digit organic growth in our automotive aftermarket business, which is gaining share in the collision and auto care markets. Advanced Materials declined year on year, impacted by ongoing weakness in the oil and gas market. On a related positive note, this business was recently awarded a $93,000,000 body armor contract from the U. S.
Defense Logistics Agency to be realized over the next 18 months. Acquisitions, net of divestitures, added 2.6% to industrial sales growth in the quarter. This figure represents the membrana acquisition net of the recent Polyfoam divestiture. Membrana continues to deliver strong results, exceeding its financial objectives since acquisition. The business continues to expand its geographic presence, which includes recent contract wins with 2 life science customers in China.
Finally, our industrial business delivered operating income of $615,000,000 in Q2 and margins rose 30 basis points to 23.4%. Please turn to Slide 9. Safety and Graphics delivered a solid quarter with sales of $1,500,000,000 and organic growth of 2.3%. Our roofing granules business posted another strong quarter of double digit organic growth as demand increased in the replacement shingle market. Commercial Solutions also delivered a solid quarter with notable strength in EMEA and the U.
S. Within this business, new product sales in architectural markets and floor care products boosted the organic growth. Acquisitions, net of divestitures, added 4.6% to sales growth in the quarter. This figure includes capital safety net of 2 small divestitures. The capital safety business is already benefiting from access to our company's 46 core technology platforms.
For example, the team recently leveraged 2 of those platforms to create and launch a new detachable self rescue fall protection device. On a geographic basis, organic growth in Safety and Graphics was led by Latin America, Canada and the U. S. At mid single digits, while Asia Pacific declined year on year. Operating income was $411,000,000 and operating margins increased 2 percentage points to 27.4%.
Profits in this business continue to be boosted by recent portfolio management actions along with solid productivity efforts. Please turn to Slide 10. Our Healthcare business delivered another strong quarter across the entire portfolio. Sales increased 3 percent to $1,400,000,000 and organic growth was 4.9%, which once again led the company. As Inge mentioned, organic growth was broad based with all businesses and geographic areas up year on year.
By geography, Latin America Canada and Asia Pacific each posted high single digit growth in the quarter. Healthcare also generated high single digit organic growth in developing countries with strong contributions from China, Hong Kong, Taiwan and Mexico. Looking by business, organic growth was led by food safety, health information systems and medical consumables. Operating income was $460,000,000 up 4.3% year over year and margins remained strong at 32.7%. Next, I'll cover Electronics and Energy on Slide 11.
2nd quarter sales in Electronics and Energy were $1,200,000,000 down 9.1% organically. Organic sales on the Electronics side of the business were down 14%. We continue to be impacted by weak end market demand across most consumer electronic applications. At the same time, channel inventories continue to adjust, and we expect these challenges to persist into the second half of the year. Our energy related businesses declined 2% organically with growth in telecom being more than offset by declines in electrical markets and renewable energy.
On a geographic basis, organic growth was down double digits in Asia Pacific, impacted by the declines in Electronics. 2nd quarter operating income for Electronics and Energy was $229,000,000 with margins of 19.3%. As mentioned earlier, during Q2, we took actions within Electronics and Energy to better position the business going forward. These actions reduced Q2 margins in this business by 80 basis points. Adjusting for these actions, underlying margins were 20.1%.
In light of continued end market challenges, we now expect full year 2016 organic sales in Electronics and Energy to decline by high single digits. Please turn to Slide 12, where I will cover our Consumer business. Consumer had another solid quarter with sales of $1,100,000,000 and organic growth of 2.7%. Organic sales growth was led by our Home Improvement and Consumer Healthcare businesses. Recent accelerated growth investments in Command damage free mounting products and scotch blue painters tape continue to pay off, driving strong double digit organic growth in both cases.
Filtrete filters continued to gain share and delivered strong growth in the quarter. In our Consumer Healthcare business, we are driving strong growth in our Futuro line of compression solutions, health braces and supports. The back to school season got off to a good start in the 2nd quarter, led by strong sales of posted and command solutions. Geographically, consumers organic growth was led by Asia Pacific along with solid growth in the U. S.
Operating income was $281,000,000 with operating margins of 24.9%. Solid organic growth, prioritization of investments and productivity efforts contributed to strong margin performance in the quarter. That wraps up my formal comments. Now I will turn the call back over to Inge. Inge?
Thank you, Nick. As I look across our enterprise, each of our businesses is facing slightly different market realities, yet all of them are executing very well. 6 months into the year, 4 of our 5 business groups are growing in line with our expectations entering the year. And for reasons we have stated, Electronics and Energy is growing below those expectations. As a result, today we're updating our planning estimates for 2016.
Organic growth is now estimated to be 0% to 1% against previous guidance of 1% to 3%. With respect to earnings per share, we are raising the low end of our guidance from $8.10 to $8.15 and adjusting the high end from $8.45 to $8.30 resulting in an expected increase of 8% to 10% year on year. We anticipate foreign currency to reduce 2016 sales by 1% to 2% versus a prior estimated reduction of 1% to 3%. And our full year tax rate is now expected to be 29% to 29.5% versus the previous range of 29.5% to 30.5%. Finally, there is no change to our free cash flow conversion range, which remains 95% to 105%.
With that, I thank you for your attention, and we will now take your questions.
Our first question comes from the line of Andrew Kaplowitz of Citi. Please proceed with your question.
Good morning, guys. Good
morning, Andrew. Good morning, Andrew.
So your price versus raw materials actually went up in 2Q to 1.3% from 1.1% in 1Q. We know you've talked about your benefit from price versus raw materials actually being front half loaded this year, The pricing has been trending a little higher than you thought. Raw materials, have they still been a little lower than you thought? You did get positive pricing in the U. S.
After nothing last quarter and really after you spoke about increased competitive environment in the U. S. So did you see an improvement in the pricing environment in the U. S. In particular?
Andy, yes, there's several things you're asking there. The Q2 and then I'll expand it to talk about the total year for price raw materials. We as I said earlier, saw 130 basis points of margin expansion from that, up slightly from where we were in the Q1. Of that 130, 90 basis points is related to lower year on year commodity prices and the other 40 basis points is coming from our pricing growth that we see not related to FX movement. Our total price growth that we posted this year, we still see the majority of that coming from adjustments we're making in pricing related to FX movement.
But once we strip that out, we still see 40 basis points of core price growth that we're seeing in our business. And we don't see a reason for that to change as we look into the second half. If you remember, Andrew, over a long period of time, we see our range for that core price growth being between 30 basis points 50 basis points. So as I look at this for the total year, we now expect the combination of price raw materials to be benefiting our margin by approximately 100 basis points. 6 months ago, I was saying I expected it to be about 50 basis points, but we're seeing some improvement in commodity prices from what we were anticipating for the second half of the year and pricing is slightly better than what we had expected.
Got it. That's helpful. And then when you look at the goals that you set out at the Analyst Day, the 2% to 5% organic growth over the next several years, 500 to 700 minute of business transformation, 125 to 175 of factory optimization. Then you think about the current environment where you may record pretty marginal organic growth this year. Does it change your urgency at all around your cost out initiatives?
Can you accelerate these initiatives at all or find more cost out if we're in a lower for longer growth environment?
Well, we are focusing on that the whole time, as you know. And the answer to it, yes, of course, we have to do it if that is what will be demanded. Now we are very early, as you know, into that 5 year plan, basically 2 quarters. But I think we have to look upon it as we roll out if there's something that needs to be done in specific segments or pockets. And if you look upon it today, 4 of our 5 business groups are, at this point in time, just in line with the expectation we had for this year.
The one that have a challenge based on the end markets is electronic and energy. And we have done a lot in that business group the last couple of years. So it's like it's not a surprise for us that they changed it in that market. We have addressed it the whole time. And we will do that everywhere as we go ahead.
But when I look upon it in terms of how solid the 4 business groups are executing the plan at this point in time, I hope that we don't need to take drastic action in those businesses.
Our
next question comes from the line of Joe Ritchie of Goldman Sachs. Please proceed with your question.
Thank you and good morning everyone.
Good morning, Joe.
Inge, maybe just touch on China for a second. Excluding electronics, China Hong Kong was down 2% this quarter. So it seems like you're seeing some weakness across some of your other businesses. So maybe talk a little bit about that. And also across the portfolio, if you can just touch on trends, whether trends got better or worse as the quarter progressed?
Yes. I think first of all, in total China, we in our portfolio there, based on how that has been built over the years, based on the China market, which was, I would say, very much related initially to export for them. We have a bigger portion there, which is electronics and industrial. And for reason that we know relative to that market had been slower maybe the last 2 years now when we start to look upon it. Nothing changed that by definition this quarter more than more pressure in Electronics.
Consumer and Healthcare is doing very well for us. So when you look into that, Consumer had 9% growth and Healthcare 11 percent growth. So both, you look upon that, it's like 9% to 11% growth in domestic businesses. That's very good. Also, when you look upon industrial, industrial improved a little bit.
But to be honest, I'm not happy with the growth rate we see for Industrial in China. So we need to see more from Industrial. And I think it's coming as we move ahead. China for us, and I talk for 3 ms now, we have been very, very precisely driving our productivity improvement there for the last, I would say, 4, 6 quarters, we have focused a lot on productivity improvement. So underlining result in China is good for us.
We need to get more growth at that market turnaround. But the encouraging thing is that domestic businesses is going very, very well for us at this point in time.
And the underlying trends, did things get better or worse as the quarter progressed?
Well, I don't know about the quarter specifically. But in my view, we will see based on comp as well, we will see China doing slightly better as we move ahead. But think about China for the year flat as we end up the year.
Okay. And then maybe Nick, one follow-up. I just want to make sure I understand all the puts and takes, especially as we get into 4Q on the margin side. It looks like your margins can be up at least 250, 300 basis points because you did all those restructuring actions in 4Q of last year. So maybe step us through the puts and takes for 4Q?
I just want to make sure I have them straight.
For just Q4? Yes. The biggest put and take in the Q4 will be our the comparison to Q4 last year, which had a restructuring. Other puts and takes will continue to be getting benefits from price raw materials. Strategic investments, as I've mentioned earlier, will be larger in the second half than it was in the first half.
So that will be part of the puts and takes. But the biggest driver that's going to change is going to be the year on year impact of the not repeating the restructuring that we had in Q4 of 2015.
Got it. We can go step through the color offline. I'll get back in queue. Thanks guys.
Thank you.
Our next question comes from the line of Rob McCarthy of Stifel, Nicholas and Company. Please proceed with your question.
Good morning, everyone.
Good morning, Rob.
Yes. Now a couple of questions, specifically on your European exposure. Obviously, you had very strong results, particularly led by Western Europe in the quarter. But given obviously recent geopolitical events, Brexit, etcetera, could you speak as to what you've been seeing in kind of your shorter cycle businesses there? And then the follow-up and there won't be a follow-up from here, so it will just be 2 parts and I will get off the phone.
Is just longer term, as you think about your ERP and other initiatives and potential SKU rationalization, do you have to rethink that in the context of an extended breakup of the Eurozone? In other words, will you have to change your long term strategy there? Because there is a strategy for further cost takeout, but I think the passive assumption is continued economic integration of the Eurozone?
Well, this is Ying. So first of all, U. K. For us is less than 3% as an enterprise in terms of revenue. And we had a very good result this quarter in West Europe, you saw with 3% organic local currency growth with all business groups growing, which is very, very nice to see, to be honest.
So we had industrial 3%, we had SEBG 2%, we had Healthcare 5%, we had EEBG 5 and we had Consumer 2. If you think about Europe and put that in perspective is what we have to do, there's no reason for us to change strategy around Europe. Our strategy have always been to have localization in terms of execution based on languages. And number 2, build up a very strong backbone relative to resources what we now do with ERP. And we have worked for a long time in order to reduce the layers in the organization and management groups, and we have regionalized Europe over 3 years ago.
So we don't have subsidiaries in every country any longer. We work on regions. So we have reduced the cost very much in terms of administration, helping the businesses with execution centrally and then execute locally with the teams in every country. There is no reason for us to change the strategy in Europe based on the outcome of the Brexit. No reason for us to do that.
The other thing that is very nice for us to see is the margin expansion that is coming for us in West Europe as well. And as I said before, when some of you have asked around which business group can add more margin expansion to you as we move forward? And the answer has always been all of them because all of them are part of West Europe. And West Europe's margins are now starting to increase in a nice way. So we're very pleased with the performance there.
There is issues in Europe, but you know what, there's issues everywhere around the world, and you have yes to stay the course and adjust if you need. But the Brexit, short term for us doesn't mean anything, to be honest, based on our operation. And I don't see a reason at this point in time to change the laid out plan we have for Europe.
Thanks for your time.
Thank you.
Our next question comes from the line of Julian Mitchell of Credit Suisse. Please proceed with your question.
Hi, thank you very much. Hi, good
morning. Hi,
good morning.
Hi, good morning. Hi, good morning. Just on the buyback, as you said, I think you spent around €2,000,000,000 in the first half. So you're running at sort of the low end of the full year placeholder. Is there anything sort of interesting in that?
Or is it the fact that the share price obviously bounced a decent amount from where you were buying in Q1? Should we read anything into your M and A appetite? And maybe just touch on how you're thinking about M and A right now as it's been a while since things like capital safety were enacted?
Yes. Julian, I don't think you should over read it. We started the year and we continue to have a range of $4,000,000,000 to $6,000,000,000 And with $2,100,000,000 through the first half of the year, we're currently tracking to the low end of the range. The pace and the amount of the repurchases is dependent on demands of capital such as for M and A, And it's also dependent on the relative value we see in the stock price. Our model is sensitive to share price, and the range that we put out allows flexibility with our capital allocation decision.
So in short, I'd say, Julien, don't over read anything in our $4,000,000,000 to $6,000,000,000 range. We're just holding to that right now, partly because there's a lot of uncertainties that can happen in the second half of the
year. Thanks.
And then my follow-up would just be on the margin guide for the year. Apologies if I'd missed it, but are you still guiding for about 150 bps of increase for the year? And then just a quick sort of corollary of that would be, should we think that Q2's increase of 50 bps year on year is the low point in terms of margin increase and Q3 should see a bigger increase year on year?
Julien, for the year, we're in the range of 100 to 150 basis points of margin expansion. Some puts and takes in there. The price raw materials we're seeing is slightly better than we did at the beginning of the year. And the lower volume and related lower utilization of assets, is the negative impacting that margin. So 100 to 150 basis points for the year.
We consider the first and the 4th quarter to be the quarters with the most margin expansion and second and third quarter to be the 2 lower quarters of margin expansion.
Thank you very much. Our next question comes from the line of Nigel Coe of Morgan Stanley. Please proceed with your question.
Thanks. Good morning, gents.
Good morning, Nigel.
Hi. So obviously, the biggest delta on full year guide at the top line is due to E and E. I think they understand that. I think Inge, you mentioned that all of the 4 segments are tracking in line with plan. Obviously, industrial is tracking a bit lower than the 0 to 3 year to date.
Do you still see a credible path back to positive growth industrial in the back half of the year?
Well, yes, I do. And part of that is, of course, the how we will be compared to last year. But we see us performing better in the second half of the year in industrial versus we have done in the first part of the year. We had a challenge this quarter specifically in United States for industrial, and that will come back as we move forward into Q3 and Q4. When you look upon the guidance in total, we see health Care and Consumer continue to perform very well, the same with Safety and Graphics, which I've talked about earlier as the business that will be the next breakout business.
And I think we saw it this quarter that it's now coming full speed. And then Electronic and Energy, as we have talked about, will be, as Nick said and I said as well, we will see decline for the year in that business to high single digits. And then industrial, I think due to the comparison, will do slightly better for us.
Yes, the company gave you the key for sure.
So that's all for we put the guidance now 0 to 1 for the company. It's very much related to electric energy.
Sure. Okay. Thank you very much. And then for Nick, UTX just sort of softly cautioned on pension next year based on where discount rates are today. You're obviously very pension sensitive as well.
I'm just wondering if you could snap the line today on discount rates, what sort of pension headwind could we look at next year?
Yes.
For our pension expense, if we staff the rates right now, it would become a headwind for us in 2017. It's really too early with 5.5 more months to go before that gets set. So I'm not going to comment on the magnitude of it. But if we stopped right now, it would be a headwind for us in 2017.
Okay. Thanks very much guys.
Our next question comes from the line of Steven Whittaker of Bernstein. Please proceed with your question.
Thanks and good morning all.
Good morning, Stephen.
Just to put a finer point on the answer to Nigel's question. I guess this is a Q3 of negative organic growth. Do you actually if you think about next quarter versus the Q4, can grow are you stepping growth to at least go organic growth organic local currency growth to go positive in the 3rd quarter still?
Yes. Stephen, let me take that one. For as we progress through the year, Q3, we could be similar to what we saw in the Q2 for organic growth, just slightly better. We'll see, as Inge mentioned, improving trends in industrial, more driven by comps. But we will continue to see declines in our Electronics and Energy business.
The 4th quarter, based on our view right now, is where we'll see the most significant year on year comp benefits for our organic growth, which will propel us into the 0 to 1 range. But the Q3, I wouldn't be looking for a dramatic turnaround from the growth rates that we've seen in the second quarter.
Okay. That's really helpful. And then just one detail point. How much did you actually end up spending then on restructuring compared to that $20,000,000 placeholder you had talked about?
Yes. For 3 months ago, I said that we expected that expense to be approximately $20,000,000 As we progress through the year, we through the quarter, we executed on all the actions we planned. The price tag for that came in closer to $10,000,000 than to $20,000,000 We found some ways to do it more efficiently. So it ended up being a slight benefit from what we were thinking.
But with the same payback dollars?
Exact same payback that we're
Our next question comes from the line of Steve Tusa of JPMorgan. Please proceed with your question.
Hey, guys. Good morning.
Hey, good morning, Steve.
Just remind us where you guys stand on the foreign exchange hedging. I know that there's a bit of kind of a carryover some years. What would if you just held the line at above 10? Would you have any kind of carryover from hedging next year?
As we go into next year, Steve, if things just stayed where they were, the biggest impact we have on our earnings in 2017 would be the diminishment of our hedging gains. So we're experiencing hedging gains this year of approximately $100,000,000 If FX did not move, that $100,000,000 would drop substantially. There'd still be slight gains in 2017, but minimal. And then just on
the pension, just remind us what the sensitivity is. You don't have to give us a number for next year, but just every 25 bps, what's the expense headwind?
This is a little dated, Steve, but at one time, the sensitivity was about $1,000,000 for every basis point.
Okay, great. Thanks a lot.
Thank you.
Our next question comes from the line of Shannon O'Callaghan of UBS. Please proceed with your question.
Good morning, guys.
Good morning, Sam.
Hey, on the Safety and Graphics margins, I mean, a lot going your way this quarter. I mean, Safety, it looks like roofing granules had a good quarter. But you talked about it as the next breakout business too, Angus. I'm just trying to figure out what margins up here at 27 plus. Is this a particularly favorable quarter mix wise and other things?
Or is this a ramp that we expect to continue?
Yes. Well, first of all, we have done a lot in that business relative to the portfolio, and it's an ongoing process. And I think that is now what we see the benefit on. When we started that process quite some year back, when we start really to look upon what we call underperforming businesses, which is the standard is very high, as you know, inside O3M when you're running at those type of margins. I think the guys have done a fantastic job relative to sort out low margin businesses that were inside of certain division in that group.
And we also, as you know, we divested some businesses, which was a converter business in France relative to license plates that was not strategically important. And by the way, we are not the converter in that industry. So I think that when you start to add things together with building out the strength in position with addition of capital safety to our personal safety business. And then you look upon the whole graphic side and the transportation side in terms of the work they have done in order to work on the mix, that is the outcome of the result. We expect this business to continue to grow and accelerate growth, in fact, and we should be able to run the margins around this area at this point in time as we move forward.
And at least our leader there, Frank Liddell here, told me that he's very confident that he can do that.
Okay, great. And then on Electronics, so the weak volumes and the excess inventory has been going on for a long time. Looks like they're going to continue. And when do you expect electronics to return to growth? And are you still comfortable with the strategic positioning there beyond kind of the near term volume challenges?
Yes. To start with your last question, the answer is yes. The electronic business is a good business for us to be in, right? We are a material science company and the strengths of our capabilities in that market is very, very strong. So from a strategic perspective, there is no question mark for me.
And when you look upon the 4 fundamentals that we have in the company in terms of technology, manufacturing capabilities and geographical reach plus brand equity, it's very, very good for us. And as we all know, in terms of electronics, it's growing, generally speaking, and we are all touched by it every day in what we do. So that is what 3 ms should be. So the question to an answer to that question is, yes, it's a place for us to be. And as you have seen, we have adjusted our structure the whole time as that market is a little bit volatile.
But as you know, volatility also have an upside and that we will be there to capitalize on that when it comes. I don't think we will see anything this year in terms of change. So I think we have to wait into sometime in 'seventeen before we will see growth, specifically in consumer electronics taking place. Now there is something called automotive electronics that is accelerating more and more. We make specific investment there in order to capture that as we move ahead.
So I would say that it's a volatile market as we speak. The team is doing an outstanding job. And you saw again here, we had 80 basis points in terms of restructuring for the quarter. You take that out, they were running over 20% again in the quarter. So despite pressure on volume, the structure is there now to be able to deliver around 20% operating income for the company.
For me, that's good. So I complement that team for what they are doing in terms of efficiency in the type of situation. And they're all preparing for when the upturn is coming. And I would like it to come soon, but I don't think we can see it 'sixteen, right? But '17 will soon be here anyhow.
Our next question comes from the line of Andrew Obin of Bank of America Merrill Lynch. Please proceed with your question.
Hi, guys. Good morning.
Hi, Andrew.
Yes. If I look at your margin, walk, organic volume was a big dragon. As I look historically, it's sort of been one of the I think it's the biggest one I have in a while. Can you just talk about the fact that given the organic growth was close to 0, why the volume drag was so big? I would imagine it relates to the consumer electronics business in Asia.
But is that where we should expect going forward, the disproportionate impact?
Andrew, I'll take that. As you look at our margin walk for Q2, what we're calling that is organic volume and utilization. And that's a little different from how it was last quarter where we had those 2 separated out. For so what's driving the utilization negative impact? First of all, having the organic growth down 20 basis points, that's part of that.
We also saw a we reduced our inventories, which in the second quarter, which has little lower throughput through our manufacturing facilities. And then the 3rd and probably most significant of these is lower asset utilization in our Electronics business, and to a lesser extent in our Industrial business. Those are the main things going on. During the second half, we expect the asset utilization to improve, but not necessarily to be positive impact for the on the margin. It will improve, and that's aligned with our expectation full year operating margin expansion for the year being between 100 and 150 basis points.
And just a follow-up question on Healthcare. You're posting 5% organic growth. Can you just talk about your internal efforts to dedicate more resources internally to healthcare? How sustainable is this growth? Is there is a structural change in the rate of growth now that you dedicate more assets internally?
And is there ability to dedicate even more resources to accelerate this growth?
Well, this is Inge. We have made a commitment many years back to accelerate investment in healthcare and that is what is paying off, right? And when I look across every geographical area and everything, we are growing when I look up on the sheet I have in front of me for health care, we are growing every place around the world except for Brazil. And it's very it's remarkable in a way that the way we're able to take market share and grow in most of the segments. And again, Food Safety led the growth with 12% in the quarter and it's broad based.
And the same is going for the oral care business is going very well. So we have that's a broad base for us in terms of growth. And we are as you recall, we decided to not only keep health information system, but also accelerate investment into that business. So it's a very high priority for us, and we are making investment in most, if not all of the divisions as we move ahead.
Thank you.
Thank you.
Our next question comes from the line of Deane Dray of RBC Capital Markets. Please proceed with your question.
Thank you. Good morning, everyone.
Good morning, Deane.
Hey, Nick, can we start with you on the tax expectation that you've lowered it slightly. Last quarter, we talked about tax would be actually higher in the back half of the year. You were going to do some repatriating of cash. Are you still doing that? Is this a net effect?
And where does the cash repatriation stand today?
Dean, when we when I guided last quarter, our expectation for tax rate for the remaining quarters of the year and for the total year, it was also at a time that we had adopted the new accounting standard on the way tax benefits are treated on the income statement related to employee stock based compensation. Our view at that time was the majority of that benefit would be coming in the Q1 and that with our cash repatriation plans, we'd be seeing a higher tax rate in the second, 3rd and fourth quarter. As far as the cash movement, that continues according to our plan. The difference that we saw during the Q2 is due to the strong 3 ms stock performance, we saw increased benefit coming from that adoption of the accounting standards through increased employee stock option exercises. And that brought our tax rate down lower than what we were expecting for the 2nd quarter.
And that's the driver for why our tax rate why we lowered our tax rate guidance for the entire year.
Great. That's a I'd call that
a high quality problem. And then for, INGA, maybe you can give us an update with a bit more specifics on membrana. The slide called out you're exceeding financial expectations. Maybe a sense about how many businesses is membran expected to touch? You made a reference that capital safety is being rolled out to there's 46 different product areas.
I would imagine membrana has probably higher potential to touch more 3 ms businesses. So maybe an update on membrana, both from the financial standpoint and new products.
Yes. First of all, the integration is going very well and we have, as you know, 1st of all, it's relative to purification business where we try to integrate that as fast as we can. And I think, first things first, make sure we integrate it into 3M, make sure we can capitalize on what we can do together with purification business and then build it out as we go. I will not give you an exact number relative to how many businesses
because I think it's more relative
to platforms where you can use it.
And I think platforms where you can use it. And I think about specifically going into healthcare and hold that area, where I think is big opportunity. So you think about that, you should be able to use it in industrial applications, but you should also be able to use it in application that is specifically into health care. In terms of the growth rate, we grew that 5% in this yes, 5% in this quarter, and we think it's like 8% plus for the year. And I think you will see the benefits in terms of all the synergy that we can drive.
So I will I cannot give you exactly a number on divisions, but think about it as bigger platforms, both in industrial and in health care specifically.
Thank you.
Thank you.
Our next question comes from the line of Jeff Sprague of Vertical Research Partners. Please proceed with your question.
Thank you. Good morning, everyone.
Good morning, Jeff.
Hey, I got on a little late Inge, so I apologize if you covered this, but I just want to touch on what's going on in auto. Can you give a little more color on your performance in the quarter? And can you scale for us the magnitude of the outgrowth that you're seeing in the business relative to production build?
Yes. First of all, automotive again did very well for us. And we had 7% growth versus outer car builds of 3. So again, we outperformed. And when I look upon it on a geographical base, we were strong everywhere.
We were strong everywhere around the world. I think maybe a little bit versus comparison earlier, maybe down a little bit in Mexico versus what we have seen before. But more than that, we saw good growth everywhere. And including Germany, we had a Jernod speaking, we had a very good quarter in Germany, and that's very encouraging. We grew 5 percent in Germany in the quarter as a total enterprise, and automotive was part of that as well.
So to answer your question, 7% up for automotive OEM versus car builds of 3%.
And then if you look forward, Inge, based on production plans and content that you know you have in hand, would you expect that 4% type of differential to hold into the next year or 2? Do you have visibility on that?
I expect that to hold as we move ahead. The advantage for us is that we can expand the application on the car, right? So we don't sell 4 tires. There's only 4 tires on the car and then maybe one spare tire. So if that's your model, you have a limitation.
Our limitation is not there, right? So we can expand applications on the car. So I would say the penetration level that that group is driving for us is very impressive in the way I look upon it. And I expect good results from them as we move ahead.
Thank you very much.
Thank you.
Okay. Our next question comes from the line of John Inch of Deutsche Bank. Please proceed with your question.
Thanks, everyone. Good morning.
Good morning, John.
Good morning. Hey, Nick. So I want to go back to ASU 20 sixteen-nine. So you guys adopted this and it gave you a $0.10 benefit in the Q1. And then you said you were going to repatriate cash to offset it, but then it looks like the lower tax rate is going to benefit you by $0.09 to $0.10 So I'm just trying to understand what's the net of this?
Is this basically that the year is it that you're not repatriating any cash or you're repatriating less? Because obviously there's moving parts with respect to your stock price and other things. So I'm just curious like what was the net benefit of these two impacts in the Q2?
Yes. From for the John, I'll first talk about the total year and then I'll try to bring it into the quarter for you. Sure. So for the year, at the time, what we were what I said 3 months ago is, yes, we're getting that benefit in the Q1, but with our cash repatriation, it will end up being neutral for the year. We now, for the year, see a total benefit of approximately $0.10 of net all in.
If we net the ASU, we net the cash repatriation. And the 3rd piece that I'll remind you of it, it also has an impact on our share count. It increases our number of shares outstanding and of diluted shares outstanding. So the net impact is we now see as approximately $0.10 for the total year. For the 2nd quarter, the roughly 150 basis points lower than we saw in our tax rate from what I had originally guided.
All of that is coming from the increased employee stock options that we saw in the Q2. Nothing has changed on our plans that we communicated for cash repatriation and cash movements around the world.
Okay. So if it was $0.10 positive in the Q1, right, and it's going to be neutral for the year. And it sounds like with the lower tax rate, it was still a positive in the second quarter. Is this a drag in the back half except that your tax rate coming down? So I guess you would expect
Yes. So in the second half of the year, we're anticipating that we'll have lower employee stock options and there, hence, lower tax benefit from that in the second half of the year. That's built into our current guidance for the tax rate. But we'll continue to be seeing the headwinds from our cash repatriation and cash movement actions that we're taking.
Okay. And then, you guys lowered the annual guide. So I mean, there's obviously you roll all this up, there's a lot of below the line moving parts, various levels of tax rate movement and swings and options and so forth. Is the implication that because you lowered your annual guidance, EPS guidance by $0.05 that there wasn't an ability to find some below the line items to provide that offset because the $0.05 isn't really that much. So I'm trying to understand if there's an implication that you're sort of saying we've already underspent on our restructuring, we've already sort of maxed out this stock option, what was going to be a headwind turn into of tailwind or whatever versus expectations.
Is that kind of the signaling here?
John, the signaling I take from that is we continue to see very good investment opportunities for the company. Opportunities that we've talked about for strategic investments, investments in accelerating growth in healthcare as I think Jeff just asked about that. So I see it as a commitment that we see opportunities and we want to keep investing in those, not we're running out of options of what we can do to deliver a current quarter or year's earnings.
Okay. That's fair. And then just lastly, what's the biggest driver of the delta for foreign currency? Like why is that is it the euro or was there some other expectation baked in? I realize you say you don't have a lot of pound exposure.
Was there some other sort of fine tuning of this?
The yen is part of that movement. That's probably the most significant deviation. The euro, I'd put very similar to what we've been expecting throughout the year.
Maybe if I could squeeze one more. And you did really well in Canada. Companies like Granger and others have done poorly in Canada. What is there any other color you could add to that market? Because that economy is sort of it's kind of very mixed, I think is the best way to put it.
Like how did you guys do such a good job, so to your credit?
I think the team up there, yes, executed very well on the plan. And the other thing that I think is important in that business was up there. We've been there for a long time. We have very good relation into the marketplace. And our service level is very good.
And one thing, I see in our business transformation starts and end with the customer, starts and end with the customer. Canada was one of the first places we have implemented that program, which is now more than 2 years ago, and it's working well for us in Canada. And when you can provide in the marketplace product that is adding value and provide good service that is based on the demand from the customer going into our ERP system, result is coming. So there's a couple of things, good growth, margin expansion, and I just think that team should be complemented for the way they operate today and the way they took on the ERP system as one of the first places for us on a global base to execute that and actually helped us a lot in terms of the rollout that you see now in Europe. So yes,
it's a
very, very nice result. Is it surprise? No, it's not. It's not. This is based on very good relation with customers, total dedication to what we call customer first and then the ERP system help the customer and us in order to lay out the demand plans and then for us is to deliver on it.
Yes. And to your credit, you also cast a spotlight on companies that don't seem to know what they're doing there. Thanks very much. Appreciate it.
Thank you.
Our next question comes from the line of Laurence Alexander of Jefferies. Please proceed with your question.
Good morning.
Good morning.
In the
vein of the business redesign as you've been in a slow growth environment for a while, do you think returns on R and D and innovation are deteriorating or improving? That is, is innovation more differentiated in this kind of environment? Or are you seeing it more challenging to get adequate returns?
I think it's an imperative for you in order to be successful. It's not eitheror. It's based on 3 ms model where research and development is the heartbeat of the company and where we add value on a very attractive price point and value point for our customers. That is helping them improve productivity and or adding value to their end products. So for me, it's an imperative in order for you to be able to run a business like we are doing with very good return to our shareholders.
It's becoming more and more important in my mind, if you would like to be successful long term that you have a very robust research and development organization with good platforms that they can use. So you need technology platforms and you need the brains and you need equally important, of course, input from your customers when you build those platforms.
Thank you.
Thank you.
Okay. That concludes the question and answer portion of our conference call. I will now turn the call back over to Inge Tuohlin for some closing comments.
Thank you. To wrap up, our team delivered another good performance in the 2nd quarter as it relates to both financial results and building for long term success. Going forward, we will remain focused on executing the 3 ms playbook, delivering efficient growth and continuing to create greater value for our customers and shareholders. Thank you for joining us, and we look forward to talking with you soon again. Have a good day.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.