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 will conduct a question and answer session. As a reminder, this conference is being recorded, Thursday, July 23, 2015.
I would now like to turn the call over to Matt Ginter, Treasurer and Vice President of Investor Relations at 3 ms.
Thank you, and good morning, everyone. Welcome to our Q2 2015 business review. On the call today are Inge Tilleen, 3M'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 22 January 26.
Also take note of our next investor meeting scheduled for December 15. More details will be available as we get closer to that date. Today's earnings release and the 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 3 ms'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 off to Inge.
Thank you, Matt, and good morning, everyone, and thank you for joining us today. Overall, this was a good quarter for 3 ms marked by broad based organic growth and margin expansion. We continue to operate in an uncertain global economic environment, which softened growth. At the same time, we grew organically in all geographic areas, expanded margins a full percentage point and increased net income. Most importantly, we maintained our commitment to managing 3 ms for the long term with strong investments in our portfolio.
Let's go through a few of the second quarter's numbers. Earnings per share rose to $2.02 a 5.8% increase year over year. Our team posted local currency sales growth of 2% company wide. On an ex electronic basis, growth was 2.2%, the same as Q1 and I will talk more about our electronics business shortly. Organic growth was positive in all geographic areas paced by the United States at 4%.
4 of our 5 business groups grew organically led by Safety and Graphics at 5%, followed by Consumer and Healthcare Businesses at 3%. Growth in industrial slowed a bit to 1% as we experienced channel inventory adjustments in general industrial markets. Electronics and Energy declined 3% organically in the quarter. This business group faced a tough year on year comparison and we also saw somewhat softer consumer demand in the electronics markets. However, even in softer market condition, we increased margins in electronics and energy to more than 21% for the 2nd straight quarter.
As you recall, last year we consolidated a number within Electronics and Energy to better align to customers and generate efficiencies and that portfolio work is paying off. I'm pleased with the progress of this business and going forward the team is focused on driving spec in wins, increasing productivity and advancing our technologies capabilities. In the Q2, we continued we saw continued strength of the U. S. Dollar, which reduced company wide sales by 7.3%.
As a result, total sales declined 5.5% to $7,700,000,000 We increased Trem's operating margins to 23.9%, up 1.1 percentage points. This marks the 7th consecutive quarter of year on year margin expansion company wide. Our margins remained strong and broad based as all business groups posted margins greater than 21%. This is a testament to the strengths of our portfolio and business model and our business teams around the world driving productivity each and every day. In the Q2, we also continued to actively deploy capital in order to improve the business and return cash to shareholders.
We returned $2,300,000,000 to shareholders through dividends and share repurchases. And just last month, we announced the acquisition of Capital Safety. Capital Safety is a leading global provider of fall protection equipment and will bolster 3 ms's personal safety business, which is a strategic priority in our portfolio. This acquisition builds upon a number Portfolio management is one of our 3 strategic levers and is vital to our success. To succeed in the long term, we must constantly evolve to meet the changing demand of our customers and the global economy.
Back in 2012, we began a comprehensive review of 3M's portfolio and started to make changes to better align our portfolio to our long term strategic objectives. This includes reallocation of resources to our best opportunities. It also means taking action to create greater value such as combining businesses within our company to increase customer relevance, scale and productivity, acquiring businesses that align with 3 ms's fundamental strength and strategic objectives and divesting businesses that no longer align with those strengths or objectives. In the first half of twenty fifteen, we took action on all fronts. Earlier this month, for example, we combined 2 of our health care businesses.
Our dental and orthodontic business, which are both recognized for their strong technology and brands, were merged to form a single oral care solution business. Now through a seamless and single partnership, we can offer customers an entire suite of oral care innovations, thus increasing our relevance and generating efficiency. In fact, since 2012, we have consolidated businesses with each of our business groups. As a result, we have moved from 6 business groups to 5 and from 40 businesses to 26. Next to acquisitions.
Earlier I talked about last month's announcement of capital safety. In February, we also announced a €1,000,000,000 acquisition of Polypro's separation media business, which will enhance 3 ms's core filtration strategic addition to our Healthcare Business Group. At the same time, in January, we sold our static control business after thorough strategic review. Because of our team's work, 3 ms is now leaner, more focused and better positioned to win big opportunities and create greater value for our customers and ultimately for our shareholders today and even more so in the future. Thank you.
And now I will turn the call over to Nick for more details on the quarter.
Nick? Thank you, Inge, and good morning, everyone. Let's begin on Slide 5, where I will describe the elements of 2nd quarter sales growth. We generated organic local currency growth of 1.8%, with volumes contributing 0.8% to our growth and selling prices adding 1%. The sales impact from acquisitions, net of divestitures, was neutral in the quarter.
Positive growth related to the Iverao Medical acquisition was offset by our divestiture of the static control business. Foreign exchange impacts reduced sales by 7.3 percentage points in the Q2. The most notable currencies impacting sales were the euro, yen and Brazilian real, which devalued versus the U. S. Dollar by 20%, 17% and 28%, respectively.
In dollar terms, worldwide sales declined 5.5% versus Q2 of 2014. On a geographic basis, the United States led the way with organic local currency growth of 4.1%. U. S. Growth was broad based, led by Safety and Graphics and Consumer at 6%, Healthcare at 4% and Industrial at 3%.
Latin America Canada posted organic growth of 0.8% in the quarter. Growth was positive in our Healthcare and Industrial businesses, while Safety and Graphics and Electronics and Energy both declined organically. Mexico delivered another outstanding result with 17% organic growth in the quarter and Brazil turned positive with 1% growth. The impact of year on year sales declines in Venezuela reduced organic growth in Latin America, Canada by 4 percentage points in the quarter. This headwind is behind us starting in Q3.
Organic local currency growth in Asia Pacific was 0.5% in the quarter, with Healthcare and Safety and Graphics each growing 9% and Consumer growing 3%. Electronics and Energy declined 4% organically in Asia Pacific. Organic growth was down 2% in China, Hong Kong in the Q2. Healthcare delivered strong growth, which was offset by declines in Safety and Graphics, Electronics and Energy and Consumer. We continue to see the Chinese economy adjusting to new growth levels and we saw channel adjustments in some key end markets which impacted our growth.
For the full year 2015, we now expect organic growth in China Hong Kong to be in the mid single digit range versus mid to high single digits previously. Japan delivered another good quarter with 2nd quarter organic growth of 2% or up 7% excluding Electronics. Healthcare and Safety and Graphics posted strong organic growth followed by steady growth in our Consumer and Industrial businesses. Turning to EMEA, organic growth was 0.4% in Q2 with West Europe declining 1%. Organic growth in Central East Europe increased high single digits, while Middle East Africa was down mid single digits.
Organic growth in EMEA was led by Safety and Graphics at 4%, Healthcare was flat and Industrial, Consumer and Electronics and Energy each declined 1%. Please turn to slide 6 for the Q2 P and L highlights. 2nd quarter sales were $7,700,000,000 Operating margins improved by 1.1 percentage points year on year to 23.9%. Strong gross margin improvements along with productivity drove the 2nd quarter operating margin performance. Let me cover the primary components of the change in margin.
On the positive side, the combination of lower raw material costs and higher selling prices contributed 150 basis points of margin expansion. Pricing performance in the Q2 remained steady driven by continued new product flow across our businesses and price increases in select countries to help mitigate the impact of currency devaluations. We continue to benefit from lower raw material costs and expect this trend to continue throughout the year. Commodity prices remain favorable and our global sourcing teams continue to generate additional cost reductions. Productivity remained strong in the 2nd quarter, adding 50 basis points to margins, driven by Lean 6 Sigma efforts, returns on past portfolio actions and continuing to prioritize investments.
Strategic investments reduced margins by 30 basis points. This includes our ERP and business transformation effort, increased R and D investments aimed at disruptive innovation, along with portfolio management actions. These investments will strengthen 3 ms for the future. Finally, higher pension and OPEB expense reduced 2nd quarter operating margins by 60 basis points. As a reminder, this year's pension expense increase is due to the adoption of new mortality tables along with the lower discount rate.
For the full year, we continue to expect operating margins to increase by approximately 1 percentage point. Let's now turn to Slide 7 for a closer look at earnings per share. Earnings per share for the Q2 was $2.02 a year on year increase of 5.8%. Organic growth and margin expansion contributed $0.12 to the EPS increase in the quarter. This result includes a negative $0.05 impact from higher year on year pension and OPEB expense.
Foreign currency impacts net of hedging reduced pretax earnings by $110,000,000 or the equivalent of $0.12 a share. The 2nd quarter tax rate was 28.1 percent versus 29.5% in last year's comparable quarter, which increased earnings by $0.04 per share. The reduction in the tax rate versus last year's Q2 was driven by adjustments to tax reserves, which were partially offset by geographic profit mix. Reserve adjustments were anticipated in our tax rate guidance. Finally, average diluted shares outstanding declined by 3% versus last year's Q2, which added $0.07 to 2nd quarter earnings per share.
Let's now review cash flow. Please turn to slide number 8. 2nd quarter operating cash flow was $1,300,000,000 down $300,000,000 year on year. The majority of the year on year decline was due to higher cash taxes. We invested $370,000,000 in capital expenditures during the 2nd quarter, up $29,000,000 year on year.
For the full year, we continue to expect capital expenditures in the range of $1,400,000,000 to $1,600,000,000 2nd quarter free cash flow was $1,000,000,000 and we converted 74 percent of net income to cash. For the full year, we continue to expect free cash flow conversion in the range of 90% to 100%. Cash dividends paid were $646,000,000 in the 2nd quarter, up $90,000,000 year on year. As a reminder, we increased the per share dividend by 20% this past February, which marks the 57th consecutive year of dividend increases. Gross share repurchases were $1,700,000,000 in the 2nd quarter, up $269,000,000 compared to Q2 2014.
Through the first half of twenty fifteen, we have repurchased $2,600,000,000 of our own shares. We now expect full year gross share repurchases to be in the range of $4,000,000,000 to $5,000,000,000 versus a prior expectation of $3,000,000,000 to $5,000,000,000 Let's now review our 2nd quarter performance on a business by business basis, starting with our Industrial business. Please turn to Slide 9. Industrial posted sales of $2,600,000,000 in the quarter, with organic local currency growth of 1.4%. Industrial's organic growth was led by 3 ms Purification and Aerospace and Commercial Transportation, each generating double digit growth in the quarter.
The automotive OEM business posted mid single digit growth in the quarter versus a slight year on year decline in global car and light truck builds. We continue to improve our market share in this large and important market. We also delivered positive organic growth in automotive aftermarket in Q2, while the Industrial Adhesives and Tapes business was flat. On a geographic basis, the U. S.
And Latin America Canada set the pace with each posting organic growth of 3%. Asia Pacific was flat, while EMEA declined 1%. The Industrial business delivered operating income of $609,000,000 in the 2nd quarter. Operating margins were a strong 23.1 percent, up 120 basis points year over year, boosted by positive price raw materials. Let's now turn to Safety and Graphics on Slide 10.
2nd quarter sales in Safety and Graphics were $1,400,000,000 increasing 4.9% organically. All businesses within the portfolio grew organically, led by the roofing granules business, which posted strong double digit growth in the quarter. Personal Safety, 1 of 3 ms's Heartland businesses, grew mid single digits in the quarter. This business is a strategic priority for 3 ms for several reasons, including our strong product portfolio, fast growing end markets, and increasing regulatory standards across developed and developing markets. As Inge mentioned, the Capital Safety acquisition will strengthen this business even further.
Geographically, organic sales growth in Safety and Graphics was 9% in Asia Pacific, 6% in the U. S. And 4% in EMEA. Latin America Canada declined 2%. Operating income was $364,000,000 and operating margins increased 1.8 percentage points to 25.4%.
Margin improvements were driven by price raw material benefits along with productivity and portfolio management actions. Let's now turn to Healthcare. Please turn to Slide 11. Healthcare delivered sales of $1,400,000,000 in the 2nd quarter with organic growth of 3.4%. We continue to see broad based organic growth across much of the Healthcare portfolio, including food safety, health information systems, oral care, critical and chronic care and infection prevention.
Drug Delivery Systems, which is a project based business declined year on year. The Ivera Medical acquisition added 70 basis points to Healthcare sales growth in the quarter. Geographically, organic growth in Healthcare was led by Asia Pacific at 9% with strong contributions from both Japan and China Hong Kong. Latin America Canada grew 5%, the U. S.
Was up 4% and EMEA was flat. Healthcare's operating income was $440,000,000 and margins rose 160 basis points to 32.3%. Primary drivers of margin expansion included strong productivity and price raw material benefits. Next, we will look at Electronics and Energy on Slide 12. In Electronics and Energy, sales were $1,300,000,000 for the quarter, down 3% in organic local currency.
Operating margins increased 60 basis points to 21.2 percent and operating income was $277,000,000 in the quarter. Our portfolio management actions in this business continue to yield benefits for our customers and improve productivity, which is leading to strong operating margin performance. Organic local currency sales declined 2% on the electronics side of the business. As Inge commented, we experienced softer conditions in the electronics market for the quarter. The business remains focused on continuing to drive successful spec in wins with electronic OEMs.
In our energy related businesses, organic local currency sales were down 3%, consistent with 1st quarter growth patterns. On a geographic basis, organic sales growth in Electronics and Energy increased 1 percent in the U. S, EMEA declined 1%, Asia Pacific was down 4% and Latin America Canada declined 7%. The divestiture of the static control business reduced sales by 70 basis points in the Q2. Please turn to Slide 13.
2nd quarter sales in Consumer were $1,100,000,000 with organic growth of 3.4%. We grew organically across the portfolio with particular strength in the do it yourself business, led by strong growth of scotch blue painters tape. Our stationery and office supply, home care and consumer healthcare businesses also delivered positive organic growth in the quarter. 2nd quarter is typically when we begin to see the impact of the back to school season. Growth has been encouraging to this point, most notably in our line of Scotch brand home and office tapes and Command solutions, which eliminate the need to pound nails into walls when hanging pictures, decorations or other items.
Looking at the consumer business geographically, organic growth was led by the U. S. At 6% and Asia Pacific at 3%. Latin America Canada was flat and EMEA declined 1%. Operating income increased to $259,000,000 and margins were 23.3%, up 2.2 percentage points year over year.
Margins were boosted by lower raw material costs, portfolio prioritization, strong productivity and timing of promotional programs. That wraps up our review of the 2nd quarter business results. I will turn it back over to Inge for an update on our 2015 planning estimates.
Thank you, Nick. Overall, 3 ms delivered a good second quarter performance. Organic growth remained broad based and we continued to generate premium margins across portfolio. Looking across 3 ms's entire team, I'm very pleased with our execution and discipline in an uncertain economical environment, which is evident in our strong productivity. Going forward, we expect that economic uncertainty remains through the year.
In fact, external growth forecasts have continued to moderate over the last several months. As a result, today we are updating our guidance for the full year. We now expect organic growth of 2.5% to 4% percent to 4% versus the prior expectation of 3% to 6%. With respect to earnings, we now anticipate EPS in the range of $7.80 to $8 versus the prior range of $7.80 to $8.10 The rest of the guidance remains in place. As you can see, we still expect currency to reduce sales by 6% to 7%.
Our tax rate guidance is unchanged to 28.5% to 29.5%. And we continue to expect the free cash flow conversion rate of 90% to 100%. Like always, our 3 ms teams are focused on executing our plan, making investment for the future and managing those things within our control, in other words, controlling the controllable. As I described earlier, our portfolio is strong and getting stronger as a result of our recent investments. Going forward, each of our businesses will continue to be bolstered by 3 ms's 4 fundamental strengths: technology, manufacturing, global capabilities and our brand.
Those strengths are leveraged across our company and will allow us to gain market share, maintain world class margins and generate efficient growth in the future. Thank you for your attention and we will now take your questions.
And our first 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 touching on organic growth for a second. You're kind of tracking towards the lower end of the full year guide so far year to date, and there still seems to be a lot of uncertainty in the environment. And so I'm just wondering how are thinking about your base case for the rest of the year, just given what you're seeing geographically and across your product portfolio?
Yes. Well, as you recall, we saw all of us, right, saw a slow economic environment coming early in the year. And after the Q1, we thought it was too early for us to change the guidance for the year. And I think now as we moved in and saw the Q2 coming through here, I think it's the right thing to make sure that we adjust that guidance. And where we now you can see basically the industrial production index came down even here a couple of weeks ago from 2.6% to 2.1%.
So based on that and based on our portfolio, we think it's prudent for us to take it now to 2 0.5% to 4% versus what we had earlier. I would say if I just comment on the organic growth for quarter, the thing that changed for us in the quarter was basically the Electronics. Electronics was 2 things. 1 was a tougher comparison versus last year. We had 10% organic local currency growth a year ago.
And then that became some softness in that segment. So when I look upon it, the Q2 is very similar to the Q1 in terms of growth excluding that piece, right? And so I think that the 2.5% to 4%, I think that's reasonable guidance for us and we should be able to come somewhere in the middle of that.
Okay. All right. That's helpful. And maybe I'll just follow-up there on the Electronics business. Typically, there's a you see some type of seasonal uptick in the Q2, particularly from a
margin standpoint. I think very few years
have you seen a sequential decline in margins, weakness. How are utilization rates? How do you view the channel from an inventory standpoint? And then how should we think about that margin trajectory moving forward?
Jill, the this is Nick. The margin we expanded margin here 60 basis points year on year against a quarter that fairly strong Q2 of last year. What's been enhancing our margin and will continue to enhance our margin is some of the portfolio management actions that we've been taking in that business that increase our cost competitiveness. That's what's been driving it in the last few quarters, and we continue to see that driving it in the next few quarters, Joe.
Okay. And then
I guess just a commentary on the end market from a utilization standpoint and from an inventory standpoint. What's your sense for what's happening in the channel today?
Well, I don't I think it's more as you know, we are expecting on most devices in the industry. And what is happening from time to time is maybe a little bit of a delay of a new product introduction. And that will, of course, then impact us immediately. So I think the way I look upon this is to say, we are making the same progress now as in the past relative to our spec in. And we didn't see any big change relative to inventory levels, which you maybe then also can see relative to purchasing, right.
So if there was a little bit of delay of some new product introductions and they didn't build inventory, right, the type of slowed it down and that's impacting us as well. I will make the comment on that business if we just put it in perspective and why I am pleased with the performance there. You recall that we started that business with margins around 15.7%, 15.8% or something and now moved that up to 21%. Percent. And the question was always is this volume driven?
And my answer was always no the action we have taken on the portfolio in order to get a more efficient organization, better aligned to customer and have better asset utilization, meaning if we will have from a quarter that will happen in that business a little bit slower growth, we will be able to hold margin at a high level, meaning it's not volume related. I think we proved that to in this quarter, we proved that that model is correct. So volume went down a little bit. And in fact, we had margin expansion in that business. For that and on the work we have done on our portfolio, I'm personally very pleased with what that team have done relative to that portfolio work.
Yes, that's a fair point. Thanks, Inge. And Nick, I'll get back in queue.
Thank you.
Our next question comes from the line of Nigel Coe of Morgan Stanley. Please proceed with your question.
Yes. Thanks and good morning guys.
Hi, good morning.
Good morning. So I think if we back out our China synergy which is a bit more a little bit choppier around the quarters. I think the growth is lowest we've seen since the recovery. So I'm just wondering maybe just Inger, maybe just some commentary on the macro environment. Do you view this as a speed bump and we get beyond this and back into that 4% to 5% zone or do you think there's something a bit more awry here?
Yes. Well, first of all, I think let's hold it to the year here where we're talking 2, 2,005, 2,004, right. So we don't go ahead of us ourselves relative to the future. But I think when I look upon it is to say, 1st of all, United States is very solid. We had a 4% organic local currency growth.
We grew in all businesses. It is very solid. And as you recall, hopefully recall, a quarter ago, that growth was slightly lower and the question was then, are you concerned about U. S? Our answer was no, not necessarily.
And I think with 4% growth here, that's good. In Asia or APAC, Japan did well. Japan had 2% growth excluding Electronic, which is the base business at 7% growth. China was slow. It slowed down and the type of adjusting to a new growth level there, and we are now talking about mid to single mid single digit for the year.
And I think we have to wait a little bit to see what will happen there. It's a big economy, as you know. We have a strong position, but I think that growth need to pick up more specifically in the domestic markets. And it was Healthcare did well for us. The other businesses went basically sideways.
West Europe, we all predicted that there will be a growth pickup based on the euro situation. So far, we have not seen that and probably will come later in the year, but I think it will be very late in the year. Latin America is doing fine. And as you see again, Mexico had 17% growth. Now it's the Q1 in many quarters that we saw a slight improvement in Brazil.
And as Nick said, Venezuela is now behind us in terms of comparison when we will go into Q3. And so I think that's my view on it. So I would say I will not talk about higher figures than the 2.5% to 4% at least that we go in for this year. And then we have to see how Q3 and Q4 will work out here.
Okay. And perhaps Inge, thanks for that commentary. You mentioned, let's say, our 3Q looks and you gave some good color on the last call on 2Q trends to date, which turned out to be pretty prescient. So Can
you repeat that on which one?
I'm just wondering how is 3Q tracking?
Nigel, we're not really seeing any change in trends from what we saw in Q2. We saw things pretty stable within Q2 and we're not seeing so far in the Q3 any change in that pattern.
Okay. That's really helpful. And just a quick one on Healthcare. You mentioned drug delivery has been product based and being weak, and that was a factor last quarter. If we back out the impact of drug delivery, how does that look how does healthcare look ex
that? That business in total, Nigel, brought down the growth for healthcare by approximately 1 percentage point.
Okay. That's very helpful. Thanks, guys.
Thank you. Our
next question comes from the line of David Begleiter of Deutsche Bank. Please proceed with your question.
Thank you. Good morning. Hi,
David. Good morning.
Good morning. This is actually Germaine Brown filling in for David.
Okay. Good morning to you.
Two questions. Good morning. Your gross margins in Q2 expanded only slightly more than Q1. For H2, should we expect a greater raw material benefit? Or is Q1 and Q2 a good guide for what we should expect for margins within the second half?
We see the raw material benefit being pretty evenly spread between first half and second half. I would say the first half is a very good guide for the second half.
Understood. And my second question is, your demand within Asia Pacific, particularly China decelerated. I'd imagine that some of that was due to lower electronics demand. But were there any other businesses or end markets that also contributed to that decline?
Our declines there, we were up in our healthcare business. Electronics and energy was, yes, of course, one of the declines. The others in China, Hong Kong were a deceleration from the growth we saw in the Q1.
Okay. And then 1 month into Q3, what are you seeing demand wise within Asia Pacific?
As I said earlier, what we're seeing in Q3, no so far no change in trajectory from what we saw in the second quarter or for the first half.
Our next question comes from the line of Steven Whittaker of Bernstein. Please proceed with your question.
Thanks and good morning guys.
Good morning, Steven.
Good morning. Could you talk
a little bit about I want to dive into capital safety a little bit since you haven't had the opportunity to do much of that. You talked about in the release 14x EBITDA multiple. I think that included synergies. It's clearly a very least I think it's a very attractive company and segment. But maybe talk through number 1, what was that multiple excluding that impact in that 1 year timeframe?
And how do you think about pricing in general, given that you're obviously allocating more funds to bigger M and A. Just trying to get a sense for how you thought about the return profile on that one and in general?
Yes. Well, first of all, the capital safety is, in our view, a perfect fit for 3 ms. Fall Protection, which is the segment, is among the fastest growing and most profitable segments in the PPE industry. And capital safety is recognized as a leader in full protection. So you take those things together, there is high complementary synergies to 3 ms's global business in Personal Safety, which is a Heartland division.
So Capital Safety, if you think about it, provide accretive growth to us and also margins both for Safety and Graphics and for overall 3 ms. And you saw the result again here for Safety and Graphics, which is very, very good, right? And have, as I said earlier, is the business group that I thought will have the real breakout as we go. So I think it is a very valid and good acquisition to us. The component annual sales growth have been over 10% for the 4 last years and the EBITDA margins is approaching 40%.
So you have all those type of things that you lay then back to the portfolio work we did where you say, well, how can we build out our businesses and make sure that we get more relevance with our customers as we move ahead and drive synergies. So when I think about it in totality and the figures you are quoting there is correct, it's actually 12x based on 5 year run rate synergies. But I think this is for us a terrific acquisition that is building out our position.
Okay. And so do you think about it in terms of return on capital over that time frame as well?
Certainly, Steve. We're looking at return on capital and looking at the time it takes us to bring this back to a return on capital. And for us, that's in the 5th or 6th year that we see this meeting on a cash basis our return on capital our cost of capital.
Okay. All right. And then just on the pricing versus raws, you already talked about the raws comment. Pricing was another 1% again this quarter, very strong, obviously, dealing with FX and other issues. Can you talk about the sustainability of pricing within that equation going forward?
Yes. Well, I'll just on the margin front, just to clarify of that 150 basis points, about 60 basis points of those basis points are coming from our price growth and 90 basis points from our raw material reductions. As far as the sustainability of price, we're at about a 1% price increase on average through the first half of the year. We see that trend sustaining through the second half of the year.
Okay. All right. And is that mostly just again, that's independent of new products. It's just pure price increases on existing on the existing portfolio?
On our existing portfolio, I would add the color that if you look at all of our price growth, the fact that we keep refreshing our product line with our investments that we're making in research and development, that does enable us through the value we're creating for our customers to be able to sustain pricing growth. But the other part of our price growth in the Q2 and for the year is also driven by movements related to FX. And if I look at 2nd quarter standalone of our total price growth, we estimate 25% of that total price growth is coming from pricing based on the value we're creating for our customers and 75% based on movements we're taking directly or indirectly related to FX movements.
Okay. That's very helpful. Thanks.
Thank you.
Our next question comes from the line of Scott Davis of Barclays. Please proceed with your question.
Hi. Good morning, guys.
Good morning, Scott. Good morning.
I was a little bit surprised in capital safety you said year 5 or 6 reach your cost of capital and I'm assuming you're I'll ask the question what you think your cost of capital is, but
let's just say for the
sake of argument it's somewhere in the 9% range. I would think when you're buying a business like this in an industry you know so well and so easily integratable that you'd be able to earn a higher return on that. On the other side
of it just indicates that maybe you overpaid. I hate
to be skeptical on that stuff, but maybe can you address it a bit?
Part of our portfolio prioritization is we know the assets we want to buy. We know where we can drive the most value. As we look at this business integrated with our personal safety business, we do see cost synergies that we'll be deriving. We see sales synergies, both of those contributing to get that result. What you're seeing here, Scott, is a result of us having a clear vision of what we wanted to add to our portfolio and also an asset that we could see bringing a good financial return to 3
I think that partially answers it. I mean, I think what I'm partially what I'm saying is if you look at future acquisitions, is this going to be the type of hurdle rate you're looking for going forward? Because from my perspective, you would probably if all you can do is earn an 8% or 9% return 5 years out risk,
you can probably get that just buying on stock.
The answer to that is not necessary, Scott. I think you have to look upon this first look upon this acquisition, 1st of all, clearly strategic in terms of the outcome of the portfolio work, right? So that's a I think that's an important element. There are certain pieces of the business that can be integrated and where we can drive synergy. Others cannot.
And the reason for that is that there's a high element of regulation and education in that fall protection. So we need to continue to invest in that and make sure that we do everything that is right. So there's 2 elements into it, right? It's some pieces from the commercialization perspective, but we can drive a lot of synergy and we will. On the other piece, I think we still need to figure out how we can accelerate that to get the return even faster.
It's a highly regulated business, as you know. And then by that, the advantage of that, the barrier to enter is very high. So you have to think about it. You get it integrated. And as you move on it, you have to make sure that you can drive more synergy.
But the answer to your question, necessarily not. This was a specific case where I saw this is a very important strategic move for us in order to build out our position here. And it's a high class asset. It's a high class asset that is very similar to 3 ms in terms of margins, returns and growth and so forth. So yes, we can always
I agree. Yes. No, that's I think more specifically just trying to get a sense of the future. Yes.
No, no. So well, if you look the other thing here, Scott, if you look upon the other acquisition we have done from Somotomo to Ceridine, etcetera, we have not even been close to this, right? But it's I would say that I we can always argue day out and day in of the valuation, did you pay too much or whatever. This is strategic fantastic move for us with a world class asset. So I'm pleased with that piece.
And now it's up to us to drive the return even faster back to us.
Okay. That's a good answer. Just to be a little bit more dig in a little bit more detail on that. You mentioned EBITDA margin of 40% and capital safety. Is that something can that be a 50% EBITDA margin business?
Or is it more a function you can bring capital safety in and the rest of your safety products business to go up? Or is it capital safety itself can see a margin lift?
Scott, we see modest gross margin expansion opportunities there. We probably see more of our cost synergy benefits coming from the back office SG and A front than on the gross margin front.
Okay. Okay. That's helpful. So thanks guys. I'll pass it on.
Okay. Thank you, Scott.
Our next question comes from the line of Deane Dray of RBC. Please proceed with your question.
Thank you. Good morning, everyone. Good morning, Deane. Congrats to Matt and Bruce on their new responsibilities.
Thank you, Dean.
Hey, just and sorry to pile on on the capital safety deal, but this was the largest deal you've ever done. And if I'm not mistaken, this was not the first time you had the opportunity to buy this asset. So why did you pass on it before? And then you are already in fall protection because I've been to trade shows where we've had demonstrations of fall protection. So how does capital safety expand your product line?
And where might there be overlaps?
Yes. You're right, Deane, that we had a small present in that segment. We were very, very small. And one thing that I've learned over the years I've done business, if you not have a reasonable good market share position, you will over time lose out, right? So you I've been in businesses over time where you think that a couple of percentage market share will take you to a better position.
It's very, very tough. So you need to come into a leading position. So that was one. So yes, we were there. We were, in my view, not relevant enough for the industry.
So very opportunistic. Now let's go back to your comment relative to why now. I talked about it in my speech before, but I have to go back to it because I think this is important element. If you don't have a clear picture of where you would like to go in the future with your portfolio, you could have a tendency to try to be part of auctions on most things that are becoming available, right? And if you are part of bidding on more things that are becoming available, you maybe don't really know if this is a real important strategic imperative for you and you should go for it.
I would say, I was not part of 2,008 2010 whatever when there was bid on assets. But maybe at that point in time, it was not clear enough relative to the portfolio where we should invest for the future. This time, it was very, very clear for me where we should go. That's the answer for me.
Ingo, thanks for that context. And just one follow-up on the Mexico organic revenue growth 17% really jumps out. What was driving that and expectations for the balance of the year?
Yes. Mexico have now been growing for almost 2 years, right? They're doing very, very well. And it's, I would say, a combination of both domestic market growing well there, but also the overall Mexican economy in terms of exports specifically into United States. And we have a very good portfolio balance in Mexico.
As you know, we've been there for a long time and we're able to capitalize on that. So I don't know exactly if I can give you the no, no, but his question is about the outlook for the for the year in Mexico. I think our growth rate year to date is around 15%, and I don't expect for the rest of the year that that would slow down. But all business is doing well there and specifically industrial is growing very, very fast.
Thank you.
Okay. Thank you.
Our Our next question comes from the line of Shannon O'Callaghan of UBS. Please proceed with
your question. Good morning, guys.
Good morning, Shannon.
Hey, on this China expectation for the Europe mid single digits, China, Hong Kong, it was up 7% in the first, down 2% in the second. What gets better from here to even get you to the mid single digits? I mean, you talked about some inventory channel adjustments. Maybe just any other color on what you expect to improve from the current rate?
Yes. I think that, first of all, I believe that healthcare will continue, very good quarter in healthcare. Healthcare will continue and consumer will improve specifically. I also think that the industrial business that is a sizable business for us will improve slightly as we go for the year. So when you think about our portfolio, we get industrial slightly better.
If we get consumer up a little bit, which we will, and then healthcare continuing, that will take us there. I don't comment on electronics, because as you know electronic is like a business that is on a regional base. Sometimes Japan is doing better than China and so forth, right? So let's see how much that would be executed in China. But it's I think there's still a time here that we have to see the adjustment in the Chinese market, but those three businesses specifically will improve for us slightly as we go for the rest of the year.
And in terms of those improvements in industrial and consumer, I mean, is that based on just sort of timing or ending of channel reductions? Or is this improvement in the current environment?
Yes. No, that is what we are counting on. We cannot count on anything else, right? But that's what we are counting on.
The channel being kind of cleared out and getting back to more normal?
Yes.
Okay. And then within the industrial business, I mean all the end markets you commented on sounded reasonably good, but the whole segment grew 1.4%. Was there anything within that segment that was dragging it down from the decent trends in auto and other stuff?
Yes. Our industrial adhesives and tape business within industrial, that's one of the businesses that was flat and that helped that contributed to bringing the total organic growth down. Abrasives is another business that was down.
And those I mean those go into a ton of different end marks. Sorry, I missed that.
Exactly. Exactly. Including in the case of abrasives, there's some oil and gas exposure there.
Okay. All right, great. Thanks, Ben.
Thank you.
And our next question comes from the line of Andrew Obin of Bank of America Merrill Lynch.
Hey, guys. Good morning.
Good morning, Andrew. Good morning, Andrew.
Just to clarify on the Safety acquisition, you said it's going to be dilutive in the first 4 in the 1st 12 months. When are we expecting to close it in the Q3, right? Is that dilution incorporated in the updated guidance?
Andrew, yes, we've said that for the 1st 12 months, we expect this to be dilutive to GAAP EPS by 0 point 0 $4 We expect this to close in the Q3 in the middle of Q3 and our guidance is not yet including the impact of either the capital safety or the completion of the Polypor acquisition. And just
to clarify, in terms of oil prices have been coming down quite a bit since the end of the quarter. And I know you've updated what you think the impact is
going to be in terms
of your inputs. But is that when did you update your outlook for oil prices? Is it updated for the decline that we've seen over the past several weeks?
Yes. It is updated. And similar to what I said in April where we see ourselves now at the high end of the range of $0.25 benefit on raw materials benefits as well as the margin impact I talked about earlier. That's reflecting where we are the most recently with commodity prices. So yes, it is reflecting that Andrew.
And just a broader question as all of a sudden North America, U. S. Is the fastest growing market, right, has lower margins, emerging markets are slowing. Are you guys thinking about adjusting your longer term plan given where the macro is playing out? Or do you think the existing game plan is adaptable to what you're seeing?
Yes. The existing game plan is adaptable to what we are seeing. It's no change from that thinking at that point in time. And as you know, if you think about the 5 year plan, we're 3 years into it. And there's always some changes going in and out in a plan, right, in terms of all metrics.
But at this point in time, of course, from an execution perspective on where you invest for manufacturing and so forth, there are some differences now versus when there were 3 years ago of where will you invest in international, right? And or why will you do it in United States? So I think that's a business call on a day to day business. But at this point in time, there's no change on the overall plan. And our playbook is working, right?
Our playbook is working.
Terrific. Thank you very much.
Thank you.
Our next question comes from the line of Steve Tusa of JPMorgan. Please proceed with your question. Hey, good morning.
Hey, good morning.
Good morning, Steve.
So I guess just back to Shannon's questions about it a little more of a in a broad sense. Can you just give us a little color on what you'd expect on a core basis for kind of how the 3rd and the 4th quarter play out? I know that you have a little bit of an easier comp in the 4th and then a little bit of a in the 3rd and then a tougher comp in the 4th. I'm just kind of curious to see his question just more broadly what gets better here from the 1.8 that you put up this quarter?
Okay. So Steve, just to clarify, you're talking total company?
Total co or core.
So the 1.8 percent, what is
the 1.8 percent kind of how does that trend in the 3rd and the 4th quarter? Is it steady or is it a little bit better than the 3rd, worse than the 4th?
In our 2% to 4%, I can't say we're seeing a noticeable difference between the 3rd Q4, if you're looking for some color on that Steve. In the 2 on the low end of the range, it would be a continuation of the growth rate that we've seen in the first half that that continues into both the 3rd Q4. If we're shade towards the middle or the high end of the range, we would start expect to start to see that occurring in the Q3 and not all in the Q4.
Okay. And did things get how did things trend as you kind of went around the quarter? How was kind of April, May, June type of dynamic?
When we look on this on a sales per billing day, we saw virtually no change in our trend between the 3 months of Q2.
Okay. And then one last question. Just on the pricing dynamics. I guess you said 70% or 75% of that is kind of ForEx related. So as we kind of lap these ForEx comps, I guess, as we move into next year, I guess you're going to have a Q1 comp.
So does that mean that that 1% is probably since your second half is probably going to be a little bit less than 7% year over year, I guess, on ForEx? Does that mean that 1% kind of starts to fade in total as we move forward?
To the extent that there's a portion of that 1% related to FX, over time, I see that fading, but not in the second half of the year. If it does fade, it will be minimal. The logical extension is we see some fading of that in 2016, not a material amount of fading in the second half of twenty fifteen.
And on the 0.2% in U. S, so is that a good kind of reflection on I guess the U. S. Is probably your most stable market. Is that a good reflection of kind of what you're seeing on the price inflation side?
So I mean, presumably, customers will come back seeing what you guys are doing on the raw side. I mean are you is it a little bit tougher to get price these days because of what's going on with the raw materials? This is more of a kind of a macro question, I guess, as well.
Well, you would assume it would be. But I think one of the advantages for us is that often our product is adding some additional profitability and productivity to our customers. So I would say, yes, a little bit tougher. But as long as you are focused on new product that are adding value into the end market, you're able to demand a slightly higher price.
Right.
Great. Thanks a lot. Thanks for calling. Our next question comes from the line of Julian Mitchell of Credit Suisse. Please proceed with your question.
Thanks. Good morning, Julian.
I just
wanted to follow-up on the industrial business. You talked about some inventory issues there in the Q2. I just wondered how severe those were and if you thought that that inventory had largely been cleared out. So the Q3 we should see a better industrial organic growth rate.
I would say that I think it will be cleared out early Q3 is my view, right? And I think it's when you listen to the result for the industrial, many businesses did well. There's a couple of businesses that I will describe more as they are not spec in, right, or designing. They're more in the consumable side like abrasives and tape and so forth. That's where we had a little bit of temper.
And I think that then hold into the channels. But I'm more optimistic as we move forward relative to that front for industrial. Data business is there, where you think about Aerospace and Commercial and Transportation at another 10% growth. Purification, another 10% Automotive OEM, as Nick said, has 6%. So many businesses there is doing very well.
It was 2 divisions that had an impact for the quarter and it was very much what I would describe as consumables into industrial tapes and adhesives and abrasives.
Thanks. And then my follow-up would just be on the free cash conversion. Is it just the tax normalization in the second half that pushes up the conversion? Or is there something else happening with working capital, for example?
Julian, there's a few things at play here. First of all, when we pay our cash taxes, there is some timing and second quarter happened to be heavier weighted. That will moderate for the total year. 2nd quarter was also a quarter of higher than normal amounts of our total pension contribution occurring in the second quarter. And then the last piece is, we did see some increases in our working capital and we expect that also to moderate in the second half of the year.
All of those 3 of those contributing to improvements in our working capital into the second half. Those are what I'd adjust for. We have normal adjustments where, for instance, for compensation, that always has a noticeable improvement in our free cash flow conversion in the second half of the year versus the first half of the year.
Great. Thank you.
And our last question comes from the line of Laurence Alexander of Jefferies. Please proceed with your question.
Good morning. Two quick ones.
Hi Laurence.
First, good morning. As you look across your portfolio in terms of where you either have a stronger new product pipeline or a high degree of confidence about pent up demand, do you see any line of sight for acceleration in 2016, 2017 in any of your larger product categories? And secondly, if this choppy soft demand environment continues for a few more years, how does that affect, if at all, your balance sheet targets?
Well, Nick will give you some comments on the balance sheet. Let me ask the comment relative to the, let's say, business groups, right? First of all, there is a very robust pipeline of new products in each and individual business group. So I don't see from that perspective a difference in between them. And but when I look upon it, we have some businesses here that is industrial is 33% of our portfolio and very strong and we are now adding even an acquisition into that moving forward.
And I think that what I call the design and spec in there is very strong credible business. So I think it will be strong. I think as I said earlier, Safety and Graphics, I've talked about that for over a year now that I believe that Safety and Graphics is the next breakout business group for us as Electronic and Energy came earlier, right? The margin have expanded quite a bit there. And I predicted that Safety and Graphics will follow and maybe do even better due to the fact of the portfolio there.
And I'm confident that that will happen. And you see our Healthcare business. Healthcare business is usually the fastest growing, highest margin for us. And 80% of that portfolio is in the developed world, meaning only 20% in the developing and that's where a lot of growth for us is coming. And again, I would say, yes, when I look upon it and try to be objective here, you see the performance of our consumer business again with very good growth, I would say, and margin expansion and a very strong brand equity.
So I would say, for the future, for what we are doing here, I'm optimistic. I'm optimistic. And it's been a lot of work on the portfolio side, get more efficiency in the organization, try to reduce unnecessary barriers internally. And as we say here at 3 ms that productivity is important and complexity is the biggest enemy of productivity and the whole team is on working on that big time. So, no, I will not make a distinction in between them.
We are in good position everywhere.
Laurence, just a follow-up or close on the last piece you were asking about the balance sheet. Our strategy with our balance sheet as far as our capital structure and our allocation of capital, we see that our strategy there robust enough to encompass a number of business models including a lower growth scenario. On the margin, what would change? And again, this would be volatile of exactly why we're seeing a more a lower growth world. But for example, CapEx, our capital allocation strategy, I think it would be natural to assume there would be less of our capital going into our CapEx capacity building.
In terms of M and A, that would depend on our view of the valuation of the opportunities. It could have an impact where things become more attractive to us, but that's highly driven by the opportunities that we see presenting at that time.
Lawrence, this is Matt. I don't we wouldn't see anything changing in terms of organic growth being the primary way in which we grow. We'd obviously dial CapEx to whatever levels of growth we're seeing, But it doesn't fundamentally change the way we think about growth acquisition versus M and A.
Thank you.
Thank you.
That concludes the question and answers portion of our