3M Co Q2 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the 3M 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, Tuesday, July 26, 2022. I would now like to turn the call over to Bruce Jermeland, Senior Vice President of Investor Relations at 3M.

Thank you and good morning, everyone and welcome to our second quarter earnings conference call. With me today are Mike Roman, 3M’s Chairman and Chief Executive Officer; Monish Patolawala, our Chief Financial and Transformation Officer; and Kevin Rhodes, our Chief Legal Affairs Officer. Please note, that Mike's and Monish's formal comments this morning will be longer than past quarters given the announcements that we made this morning. Therefore, when we get to Q&A, please keep it to one question and one follow-up so that we can try and get to everyone as efficiently as possible. Also note that today's earnings release and slide presentation accompanying this call are posted on the homepage of our Investor Relations website at 3m.com. Please turn to Slide 2. Please take a moment to read the forward-looking statement. During today's conference call, we will be making certain predictive statements that reflect our current views about 3M'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-K and 8-K lists some of the most important risk factors that could cause actual results to differ from our predictions. Please note throughout today's presentation, we will be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the appendix to these slides and in the attachments to today's press release. With that, please turn to Slide 3, and I'll now hand the call off to Mike. Mike?

Thank you, Bruce. Good morning, everyone, and thank you for joining us. Today is an exciting and important day for 3M. We are positioning our company for future success by creating more opportunity while reducing uncertainty. We plan to spin off our healthcare business, which will result in two world-class public companies that are global leaders with significant growth opportunities in the respective markets. We intend to execute a tax free spin-off creating a global diversified healthcare technology leader. New 3M will remain a leading global material science innovator, serving customers across a range of diverse and attractive end markets. Each company will be well capitalized, more agile and focused and well positioned for long-term success. Also, we are proactively taking steps to resolve litigation related to Combat Arms earplugs. Aearo Technologies, a 3M subsidiary has voluntarily elected to initiate Chapter 11 proceedings. This process is intended to resolve claims related to Combat Arms in a manner that is efficient and equitable. 3M has not filed for Chapter 11. Both 3M and Aearo expect to continue to operate in the ordinary course. And as we announced earlier in our earnings press release, 3M continues to deliver in a challenging environment with adjusted earnings per share of $2.48 in the second quarter. We also posted organic growth of nearly 5%, excluding the impact of disposable respirators and COVID-related lockdowns in China. Monish will cover our Q2 results in detail after my remarks. Please turn to slide four. Now, is the right time for 3M to act as we position our company to win in a rapidly changing world. As I shared at our investor meeting in February, disciplined portfolio management is foundational to our growth strategy. Our Board and management team actively evaluate strategic options to drive long-term sustainable growth. The importance of portfolio management has never been greater, especially given the extraordinary macroeconomic changes brought about by the pandemic. I'll speak to Healthcare in a moment, but let me first talk about the strong businesses that will make up new 3M. Our market-leading business groups are aligned to highly attractive end markets with tremendous opportunities in front of them. Each of these business groups grew above 8% in 2021 and are delivering solid results in a challenging environment this year. Together, these businesses make up an outstanding portfolio that actively leverages our world-class capabilities. As global megatrends have accelerated, many of those trends demand our customer-driven innovations that align our growth priorities. Areas such as electronics, safety, mobility, digitization, home improvement, and sustainability, all represent significant opportunities for 3M. An important example of our strategic portfolio management is the progress we have made in health care. Through organic investments in innovation, strategic M&A and updates to our operating model, we have positioned Healthcare to be successful as a stand-alone enterprise. In 2019, we acquired Acelity and M*Modal, establishing our leadership in Advanced Wound Care and in Health Information Systems. Also, we have divested drug delivery and are in the process of separating our food safety business. Our business group-led operating model, which we implemented in 2020 has also enabled our businesses and R&D to be closer to our customers. These actions, in addition to Healthcare's strong capabilities are why we feel now is the right time to formally operate as a stand-alone healthcare leader, especially given important trends that favor our business. With shifting demographics, growing demand for virtual and in-home care, a focus on reducing rehospitalizations, advances in healthcare IT systems, and a growing focus on delivering better patient care at a lower cost, our Healthcare business is at the intersection of data, analytics, and technologies needed to deliver precision medicine. Both companies will sharpen their focus to continue investing and winning in global end markets and have greater flexibility to strategically deploy capital, drive innovation, and accelerate growth. Turning now to slide five. Our actions will drive long-term value for our shareholders. New 3M and Healthcare will tailor their capital allocation and investments to drive innovation and growth. As leaders in their markets, their enhanced focus will help position each to respond even faster to shifting industry dynamics and needs. They will both offer distinct and compelling investment profiles appealing to different investor bases. These actions will help unlock and unleash value for 3M and the Healthcare business and chart an exciting course for our future. At the same time, we are also working to reduce uncertainty by efficiently and equitably resolving Combat Arms Earplug Litigation. I will now provide more detail about our planned spin-off of our Healthcare business and the opportunities this will create. Please turn to slide seven. Each business will be financially strong leaders in their respective industries. 3M will be an approximately $26.8 billion business and remain a leading provider of innovative solutions for a broad diverse range of end markets, including industrial, safety, automotive, electronics and consumer. Each of these businesses benefit from 3M science and innovation. Our Healthcare business drove $8.6 billion in sales in 2021, which includes approximately $400 million in revenue from our food safety business. We intend to complete the previously announced separation of the food safety business through a split-off transaction with a targeted closing date of September 1, 2022, subject to approval by Neogen shareholders, in addition to other customary closing conditions. Our go-forward healthcare business will build upon strong positions in attractive markets, including wound care, oral care, healthcare IT and biopharma filtration. Next slide, please. With our fundamental strengths in science and technology, manufacturing, global capabilities and iconic brands, we are well positioned to capitalize on and invest in key megatrends. A hallmark of 3M is our ability to leverage unique and differentiated technologies across our organization, allowing us to create new solutions required by a world where we are seeing accelerated demand for innovation and sustainability. We will continue to actively manage our portfolio with discipline and focus, generate strong margins and cash flow and grow earnings by improving operating rigor. Our capital allocation priorities remain unchanged. These include investing in organic growth, an attractive dividend, strategic M&A and finally, share repurchases. Next slide, please. As we look ahead, innovation, talent and operations will remain core strengths for new 3M. We will drive more customer-focused innovation, leverage data and insights from our retail partners and connect with customers through advanced e-commerce strategies. We will share technology platforms and leverage R&D across the enterprise, which will help drive growth in all of our businesses. Attracting and retaining talented people are top priorities. We will connect them through greater flexibility with our Work Your Way model and continuously strengthen our culture of innovation. We will also advance our capabilities through digitization to provide unique solutions and achieve greater end-to-end performance across our global operations. Our innovative manufacturing expertise will continue to be a differentiator and to ensure greater connectivity to customers, we will enhance our service and streamline our operating model. We are equally excited for the future of our Healthcare business, which I will explain on Slide 10. Our Healthcare business enables better, smarter and safer care and we'll be well positioned to support customer needs and make the most of attractive opportunities, including a growing focus on infection prevention to help providers reduce related rehospitalizations, hospitals increasing investments and improvements in clinical and operational workflows to drive efficiencies and improve patient experiences, more frequent use of biologics as a first-line choice of treatment. In addition, medicines are becoming more complex and advanced, requiring specialized, tailored solutions. And the combination of material science and digital science, especially within oral care, is changing the patient experience for the better. With our deep and diverse portfolio of trusted brands, global capabilities, regulatory expertise and leading positions in attractive segments, we expect the health care business to generate strong recurring revenues, margins and cash flow. Next slide, please. We are excited about the health care business we have built, with intention and a clear focus on helping improve the health of people around the world. Our business is powered by core strengths, including our proven leadership in multiple care pathways, our position in attractive end markets, an innovation mindset, customer relationships, regulatory expertise and operational excellence. These strengths enable strong sales growth and profitability and importantly, deliver better patient care. Next slide, please. We are well positioned in large and growing health care end markets, which are expected to grow at a strong and steady rate over the next several years. Our wound care business is a world leader and comprises a portfolio of innovative products. Our oral care business is another leading platform, which has developed award-winning innovations. Health care information systems are increasingly essential, as providers seek to deliver better care through comprehensive data and insights. Our biopharma filtration products are critical to manufacturing potentially life-saving medical devices, vaccines, drugs and therapeutics. Now let me turn to some of the specifics of the transaction on the next slide. 3M plans to pursue a tax-free spin-off and retain a 19.9% stake, which we expect to monetize over time. We expect health care will be spun off with net leverage of 3 to 3.5 times adjusted EBITDA and will delever rapidly, given the business' strong cash flow. Subject to the satisfaction of certain conditions, we anticipate completing this transaction by the end of 2023, and we anticipate no change in 3M's capital allocation priorities through separation. In addition, 3M will retain responsibility for non-health care-related litigation, including Combat Arms Earplugs and PFAS. Over the next several months, we will begin our work to stand up these two companies, and we'll share updates as we progress. Now let me provide some additional background on Combat Arms litigation. Please turn to slide 15. To provide some context, in 2008, 3M acquired Aearo Technologies, which manufactured Combat Arms Earplugs. Since the acquisition, Aearo has continued to operate as a wholly owned subsidiary of 3M. These products provided effective hearing protection when used properly, and we stand by their performance. The US military continues to rely on 3M products, including newer versions of the Combat Arms Earplugs. Nonetheless, there has been an extraordinary increase in litigation related to Combat Arms. As of June 30, 2022, there were approximately 115,000 filed claims and an additional 120,000 claims on an administrative docket. The multi-district litigation process and the highly variable outcomes it has generated has not provided certainty or clarity. We believe that litigating these cases individually could take years, if not decades. We want to do right by veterans and all stakeholders, and we expect the steps we are taking today will provide greater certainty as we take action to efficiently and equitably resolve claims related to Combat Arms. We have made the decision to adopt a new legal strategy. So let me provide a little more context on the actions we are taking. Aearo has voluntarily elected to use well-established Chapter 11 procedures to resolve this litigation. Aearo will indemnify 3M for all liabilities related to Combat Arms and certain discontinued Aearo respirator mask products. 3M has entered into a funding agreement and has committed to fund a trust of $1 billion to resolve all claims determined to be entitled to compensation. This amount is based on the analysis of an experienced estimator of claims in Chapter 11. In addition, we are committing $240 million to cover projected case related expenses. 3M will provide additional funding if required under the terms of the agreement. By taking these actions, we expect to provide greater certainty and clarity and help funds go to plaintiffs with claims that are determined to be entitled to compensation sooner. This will help reduce the cost and time that could otherwise be required to litigate thousands of cases. Let me now say a few words about our plans to manage PFAS. 3M stands by our record of environmental stewardship. We are already deploying state-of-the-art technology that will help us achieve our goal of a 99% reduction in PFAS discharges from our operations. We are making progress against our goals of improving water quality, reducing water use, reducing plastic use and achieving carbon neutrality. In addition, we continue to remediate at sites where 3M historically manufactured or disposed of PFOA and PFOS. Now specifically to PFAS related litigation. We plan to vigorously defend ourselves. We are preparing our defense for upcoming milestones in the litigation process, and we are well-advised of our options. Next slide. We are excited about the future of 3M. Our actions today will provide greater focus for our organization. Before I turn it over to Monish, I want to reiterate a few key takeaways. Our investments in innovation, our portfolio management strategy our realigned operating model will power our future growth. We will have dedicated teams to help facilitate focused execution of our actions announced today. Our planned tax-free spin-off will result in a leading global diversified health care technology company. We will create more opportunity for both 3M and the newly stand-alone health care business through this transaction, with two public companies well-positioned to drive future success. In addition, we are taking action to efficiently and equitably resolve Combat Arms litigation. Finally, we remain focused on delivering in a challenging environment. Now I will turn it to Monish to provide an update on our Q2 performance and an updated outlook for the year. Monish?

Thank you, Mike, and I wish you all a very good morning. Please turn to slide 17. The 3M team executed well and delivered solid Q2 results by remaining focused on serving our customers, while navigating continued supply chain challenges, inflationary pressures along with the geopolitical and COVID dynamics. Second quarter total sales were $8.7 billion, which increased 1% on an organic basis versus last year's 21% comparison. Adjusted operating income was $1.8 billion, with adjusted operating margins of 21% and adjusted earnings per share of $2.48. We continue to experience strong demand across most end markets. However, a couple of items had a negative impact on overall Q2 results which we had highlighted during the quarter. First, as forecasted, we experienced a year-on-year decline in disposable respirator sales of approximately $150 million; and second, the Greater China region's COVID-related lockdowns resulted in a sales decline of approximately $140 million year-on-year. The impact was lower than the $300 million headwind we had anticipated as the reopening of our facilities in June went better than anticipated. Our China team did a tremendous job adding additional shifts to ramp up production, distribution, and drive productivity to serve our customers. Adjusting for these two impacts, organic revenue growth was nearly 5% for the rest of 3M in the quarter. Also, the continued strengthening of the US dollar resulted in a foreign currency translation impact of minus four percentage points to Q2 total sales growth. This FX impact, combined with the China COVID-related lockdown, negatively impacted second quarter operating margins by nearly one percentage point and earnings by $0.24 per share versus our expectation of $0.30 as discussed during a conference in early June. We also continue to support our people and manage the business and supply chain impacts from the ongoing Russia-Ukraine conflict. We also announced additional investments to resolve matters related to our operations in Zwijndrecht and began the process of restarting manufacturing operations, which is progressing to plan. And finally, as I will expand upon later, we are updating our full year expectations, primarily to incorporate the impact of the strong US dollar, along with macroeconomic uncertainty. Please turn to slide 18, where I'll get into more details of the quarter. On this slide, you can see the components that impacted our operating margins and earnings per share performance as compared to Q2 last year. First, we continue to benefit from selling price actions, restructuring savings, and strong spending discipline, which helped drive an improvement to underlying margins of 2.9 percentage points or $0.44 to earnings per share year-on-year. These actions helped to more than offset headwinds, including the forecasted decline in disposable respirator demand, which negatively impacted Q2 operating margins by 40 basis points and earnings by $0.09 a share. The previously mentioned China COVID-related lockdown, which resulted in a year-on-year headwind of 70 basis points to operating margins and $0.11 to earnings per share. And finally, as discussed during last year's second quarter earnings call, we realized a benefit to both operating margins and earnings in Q2 last year from a Brazilian Supreme Court social tax ruling, which led to a 100 basis point margin and $0.12 per share headwind to this year's second quarter. We also continue to prioritize investments in growth, productivity, and sustainability to drive long-term performance and capitalize on trends in large attractive markets, including automotive, safety, healthcare, electronics, software, and home improvement. Moving on to raw materials and logistics. Inflationary pressures resulted in a year-on-year headwind of nearly $270 million in the quarter or a negative impact of 3.1 percentage points to operating margins and $0.36 to earnings. Halfway through 2022, we have experienced approximately $480 million of raw materials and logistics headwinds versus our original full year expectation of $350 million to $450 million at the start of the year. We now anticipate this year full year headwind to be in the range of $750 million to $850 million, which we continue to expect to offset through pricing actions. As I mentioned earlier, foreign currency translation was a negative 4 percentage point impact or a reduction of nearly $340 million in total sales and over $80 million in operating income net of hedging year-on-year. This resulted in a headwind of 10 basis points to margins and to $0.13 to earnings per share. Other financial items increased earnings by a net $0.10 per share year-on-year, driven by benefits from a lower share count and tax rate. Please turn to Slide 19. Second quarter adjusted free cash flow was $1 billion with conversion of 68%. Our year-on-year conversion performance was a result of a higher-than-expected increase in working capital, along with the cash impact from capitalization of R&D for US tax purposes. Working capital improvement is a big piece of how we keep generating good strong cash flow for 3M. The global supply chain and logistics environments remain challenging. The data analytics platform that we have created will help us to reduce inventory levels through better demand planning, SKU rationalization and use of visualization tools. We expect the benefits of these efforts to start showing up in the second half and years to come. Capital expenditure was $384 million in the quarter and $808 million year-to-date or up 15% year-on-year as we continue to invest in growth, productivity and sustainability. For the full year, we continue to anticipate CapEx investments in the range of $1.7 billion to $2 billion. During the quarter, we returned $848 million to shareholders through cash dividends. As we have communicated previously, share repurchases remained suspended in Q2 due to the pending food safety separation. We intend to complete the separation through a split-off with the closing date of September 1, subject to Neogen shareholder approval and other customary closing conditions. Net debt stands at $13.3 billion, up approximately 4% as we continue to invest in the business. Please turn to Slide 21 for our business group performance for Q2. I will start with our Safety and Industrial business, which posted sales of $2.9 billion or up 0.7% organically compared to last year's second quarter. This result included headwinds from the decline in disposable respirator sales of approximately $150 million year-on-year, which negatively impacted Safety and Industrial's organic growth by 5.7 percentage points, along with the COVID-related lockdowns in the Greater China region. Our personal safety business declined high single-digits organically, primarily due to the decline in COVID-related disposable respirator demand. We continue to anticipate that COVID-related disposable respirator demand will decline as we move through 2022. However, we remain prepared to respond to changes in demand as appropriate. Turning to the rest of Safety and Industrial. Abrasives, electrical markets and closure and masking businesses all grew low double digits organically. Roofing granules, automotive aftermarket and industrial adhesives and tapes, all delivered low single-digit organic growth. Safety and Industrial's second quarter adjusted operating income was $630 million, down 12% versus last year. Adjusted operating margins were 21.5%, down 2.1 percentage points. Adjusted operating margins were impacted by China lockdowns and manufacturing productivity headwinds, which were partially offset by spending discipline and benefits from restructuring actions. Moving to Transportation and Electronics, which posted sales of $2.3 billion, up 0.5% organically compared to last year. Organic growth was held back by the lockdowns in China, along with the ongoing impacts of the semiconductor supply chain constraints on the automotive and consumer electronics end markets. Organic sales in our auto OEM business were up low single digits versus flat global car and light truck builds as we continue to gain penetration on automotive platforms. Our electronics-related business declined low single digits organically with decreases across consumer electronics, particularly smartphones, tablets and TVs. These declines were partially offset by continued strong demand for our solutions in semiconductor, factory automation and automotive end markets. Turning to the rest of Transportation and Electronics. Advanced Materials and Commercial Solutions grew organically mid-single digits, while transportation safety was down high single digits. Second quarter operating income was $476 million, down 7% year-on-year. Operating margins were 21%, down 80 basis points year-on-year. Operating margins were impacted by manufacturing productivity headwinds due to China's lockdowns and the continued shutdown during Q2 of certain operations in our Zwijndrecht factory. These impacts were partially offset by the strong spending discipline and benefits from restructuring. Looking at our Healthcare business, which delivered strong quarter sales of $2.2 billion, with organic growth of 4.4%. Our medical solutions and oral care businesses increased low single digits organically. Second quarter US elective medical procedures and oral care volumes were approximately 90% to 95% of pre-COVID levels, up sequentially from Q1 levels. Health Information Systems grew mid-single digits, driven by strong growth in revenue cycle management. The separation and purification business increased high single digits with sustained demand for biopharma filtration solutions for COVID-related vaccines. And finally, food safety was flat year-on-year. Healthcare second quarter operating income was $494 million, down 10% year-on-year. Operating margins were 22.7%, down 2.6 percentage points with strong adjusted EBITDA margins of nearly 30%. Year-on-year, operating margins were impacted by manufacturing productivity, investments in the business and costs related to the food safety separation. These impacts were partially offset by the benefit from leverage on sales growth, strong spending discipline and benefits from restructuring actions. Lastly, our consumer business posted second quarter sales of $1.3 billion or down 2.5% year-on-year on an organic basis versus last year's 18% comparison. The home improvement business was down high single digits organically, while consumer health and safety declined low single digits as both businesses were up against strong comparisons from a year ago. Our Stationary and Office business performed well, up mid-single digits year-on-year and Homecare was up low single digits. Consumer's operating income was $247 million, down 15% compared to last year. Operating margins were 18.5%, down 2.2 percentage points year-on-year. Our consumer business operating margins were impacted by ongoing supply chain constraints and manufacturing productivity impacts. These headwinds were partially offset by strong spending discipline and benefits from restructuring actions. Please turn to Slide 23 for a discussion on our 2022 outlook. As you know, the macro environment remains uncertain with mixed trends and signals across geographies and end markets. For example, improving build rate trends in automotive; continued strong demand in semiconductor, data center and factory automation; increasing healthcare elective procedure volumes; and a strong bounce back in China, following April and May COVID-related lockdowns. However, there are also continued challenges and areas of concern that we are monitoring, including the stubborn and evolving impacts of COVID; global supply chain and logistics challenges; persistent and broad-based inflation, which is pressuring consumers' purchasing power and shifting spending patterns; softening trends in consumer electronics; and geopolitical uncertainties, particularly in Europe. We are working through these challenges and are taking actions such that we expect to offset the majority of these headwinds. However, as I mentioned earlier, the strength of the US dollar is having an increasing impact on our top and bottom line, which is the primary factor driving our update to full year guidance. Foreign currency translation is now expected to be a full year headwind on of minus 4% versus minus 1% previously. This FX headwind is resulting in a reduction of over $1 billion in annual sales and is also accounting for nearly 80% of the adjustment in our full year earnings expectation. Therefore, we now expect full year earnings in the range of $10.30 to $10.80 versus a prior range of $10.75 to $11.25. Given our first half performance, along with the continued uncertain environment, we also believe it is prudent to adjust our organic growth expectations. Therefore, we now expect full year organic growth in the range of 1.5% to 3.5% versus a prior range of 2% to 5%. And finally, we expect adjusted free cash flow conversion to be in the range of 90% to 100%. Before I wrap up, let me make a few comments regarding the third quarter. First, we currently anticipate an approximate 5 percentage point headwind to total sales from foreign currency translation. While build rate forecast for automotive have moderated, we see easier comps here in Q3 versus last year. US medical elective procedure volumes are expected to be in the range of 90% to 95% of pre-COVID levels, while oral care volumes are estimated at approximately 90%. We expect a headwind of $100 million to $200 million year-on-year from the ongoing decline in disposable respirator demand. We continue to closely watch weakening consumer electronics demand trends and overall consumer sentiment and spending. And finally, looking at raw materials and logistics costs, we anticipate a Q3 year-on-year headwind of approximately $225 million, which we expect to be able to navigate and offset through price actions. To wrap up, our team delivered 1 percentage organic sales growth in the quarter, 21% adjusted margins and generated $1 billion in adjusted free cash flow. I want to thank our customers and suppliers for their partnerships and the 3M employees for their hard work and dedication, as they continue delivering for our customers. While the macro environment continues to be extremely fluid, the 3M team remains focused on serving our customers and delivering a strong second half of the year. We will remain focused on investing in favorable macro trends, increasing operating rigor through a focus on deep root causes and driving working capital intensity to further strengthen cash flow. I'm excited about the future of new 3M and our health care business. We believe that today's announcements position the company to drive significant long-term value for our customers, employees and shareholders. Our businesses and capital structure are strong, and we are well positioned for success. That concludes my remarks for the second quarter. With that, we will now take your questions.

Our first question comes from Andrew Obin with Bank of America. You may proceed with your question.

Yes. Good morning.

Hey, Andrew.

Yes. First of all, congratulations on achieving these key milestones. I'm sure the team worked incredibly hard to achieve that. So congrats.

Thank you, Andrew.

My first question, and maybe not for Mike or Monish since Kevin is on the phone as well. We're getting a lot of questions about the structure for the Combat Arms. Kevin, could you talk about the process for ring fencing the Combat Arms liability? You highlighted an estimator; how much of that estimate is discretionary in nature, and how much is based on precedents? Please explain the process a little better to us, because my understanding is that it is a fairly complex process to come up with a number. Any help would be useful. Thank you.

Maybe I'll start, Andrew, and Kevin can add some details. As we mentioned in the prepared remarks, Aearo Technologies operating entity within 3M is voluntarily taking on this liability. It's about 3M stepping up to do what's right, supporting veterans and providing greater certainty and clarity for everyone involved. We are committed to funding the trust based on the analysis of an experienced claims estimator. The third-party economic consulting firm Bates White developed the estimate for us. We believe $1 billion is the appropriate amount based on that expert analysis, and as part of this process we'll provide additional funding if required under the terms of the agreement. Kevin, do you have anything to add?

Yes. Thanks, Mike. I'll just add that the analysis will be explained in the next report that will be reviewed as part of the Chapter 11 proceeding. It's important to note that the Chapter 11 court will oversee this process and the claimants will be represented as well. And the goal is to have the court help Aearo establish this trust funded by 3M, as Mike said, and those seeking compensation can present their claims to the trust rather than going through the litigation process on a case-by-case basis.

And does this number get updated on a regular basis in the Q or intra-quarter, or it's just we're going to get big updates as things evolve or no updates at all?

So this is the commitment to fund the trust of $1 billion at the end of the process when the trust is established, that's when the proceeding will be concluded.

Got you. Thank you. And just a follow-up question. I guess this question is for Mike. There's a lot of talk about recession, right? There are headlines that we're technically in a recession. You did address inflation, consumer slowing. But just from your perspective, you have such broad exposure to the economy. What do you think we are in the economic cycle? And how does it sort of figure in your planning for the second half of the year and as you start initial budgeting process for 2023? Thanks a lot.

Yes. Andrew, maybe I'll start. In Q2 we saw most of our end markets remain strong, but like everybody else we saw some softening in the macro, both IPI and GDP. As we look forward, it's really important in the current economic backdrop to look at individual markets, and we're seeing some positive signs. Elective procedures are continuing to improve sequentially. We expect build rates for automotive to improve in the second half versus the first half. There are some areas of softness in our individual markets. Consumer electronics, for example, now has an outlook for the full year that will be negative growth for that segment. We're watching consumer and retail spending closely, with a focus on inventory and retail customers, and also the general dynamic around spending as inflation causes shifts in where consumers are spending their money. We see Europe and broadly EMEA down in the second quarter, impacted by geopolitical issues, COVID, and inflation, so there is some softness there as well. All of this leaves us with uncertainty around the economic outlook. Going into the second half, we are cautious about where the economy is headed and are watching it closely.

Andrew, I have to add FX, foreign exchange, down 4% for the year, down 5% for the third quarter. As you know, that strong dollar does impact our earnings. And that's why 80% of our guide down was due to FX. So that's the other piece I would add to Mike's comments.

Really appreciate it. Thanks a lot.

Our next question comes from Scott Davis with Melius Research. You may proceed with your question.

Good morning, and congrats on the health care spin announcement. That seems like a smart move. I hate to chime in on Monish here, but on slide 18, since you don't give us price anymore, can you give us at least some sense of what you've got with a $0.36 raw material impact, whether price came close to offsetting that, or just give us a little bit of sense of the progress you've made on the price cost?

Sure, Scott. I'll take that. As I've mentioned before, the teams have done a very disciplined approach to pricing actions across multiple markets, multiple geographies. As you know, we don't do just cost plus pricing. So we take into account our competitive position. We take into account market situations, the inflation that has by commodity. So when you put all that together, I would say, between the businesses and the product line, that's somewhere between low single digits to high single digits. But if I do a weighted average of that, I would say mid-single digits, Scott, is where we came in on price. So we did offset inflation. As I mentioned in my prepared remarks, we are managing inflation through pricing actions. And in the second half, we continue to see broad-based inflation. So we updated our inflation guide to nearly 750 to 850 versus the earlier range we had, which was in the 350 to 450 range. And even there, we continue to manage that inflation, we continue to take price. I don't know if I answered your question, but I think that was your question.

Yeah, no, that's helpful, Monish. And just going back to Andrew's question on slide 15, where you say Aearo Technology has always been operated as a wholly owned subsidiary: is there some sort of litmus test on whether it was truly integrated, whether funds were coming in, or the ERP systems were moved over? I mean, I just remember, effectively from the asbestos days, that there were lines it couldn't cross to keep something separate and put a liability into a separate entity like this?

Yeah. So Aearo, I'll take this. So Aearo has been a wholly-owned subsidiary since the 2008 acquisition. It has continued to operate and it's important to note that the Aero entities have been involved in the Combat Arms litigation from the beginning. They are named as co-defendants in the litigation and they launched, manufactured and actually sold the majority of the Combat Arms Earplugs that issued before the 2008 acquisition by 3M.

And Scott, we don't see a reason why we can't have our systems, especially your question on ERPs, separate the two entities up.

Okay. So ultimately, there will be a judge's ruling on that, I would assume, perhaps. Is that correct?

Yes, it's correct.

Okay. Thank you. I appreciate it.

Yeah. Thanks Scott.

Our next question comes from Andrew Kaplowitz with Citi. You may proceed with your question.

Hey, good morning guys.

Good morning.

Good morning.

Mike, can you give a little more color on what you're seeing by region? I know you mentioned Europe and potential weakness there in the second half. But you also talked about China and stronger-than-expected improvement in June, and it was down 8% in Q2. So what do you think growth looks like for the rest of the year there? And how worried are you about a bigger slowdown in Europe?

Maybe I'll give you more detail on those two areas. In China, as Monish highlighted in his prepared remarks, we saw a better-than-expected recovery in June from the lockdowns that produced a soft April and May. For the quarter, it's down high single-digits year over year, and GDP still looks positive in Q2. Going forward, the key will be how quickly activity recovers and what further impact COVID or any additional lockdowns might have. China remains an important market for 3M; the macro backdrop is generally positive, but much depends on how the COVID situation and recovery progress through the quarter and the rest of the year. In Europe, declines were driven by Consumer and Safety and Industrial, while Healthcare grew strongly and we saw strong growth in some individual market segments. Overall, the outlook and growth are market-dependent rather than broad-based. Europe faces geopolitical risks, supply chain issues and inflation, so it was down in the quarter and we expect a soft outlook for the second half.

That's helpful, Mike. And then maybe you could give a little more color on how the change in the way you're approaching the Combat Arms situation is impacting your total litigation costs. Does it lower 3M's overall litigation costs even in the short to longer term? How does it work in terms of the fact that you've been spending, call it, 5% to 6% of EPS and you've separated that for us? Does that now go down or go up? How do we think about that with the change today?

Yes. So the way we work, Andrew, is when we came into the year, we had told you approximately $0.60 of adjusted earnings of litigation-related expenses. That number has been updated for three items. Item number one is the pretax charge that we will take as a part of the Combat Arms litigation, which is approximately $1.2 billion. The second one is the charge that we announced earlier in the quarter about our Zwijndrecht thing, which is $355 million. And for the year, that will be approximately $500 million. And then the item which was around $0.60 of litigation-related expenses now with the way this transaction will work out is around $0.55. So put all that together, that's approximately $2.2 billion of adjusted earnings for litigation-related and Zwijndrecht-related items. So hopefully, that answers your question.

Thanks for that Monish.

Our next question comes from Stephen Tusa with JPMorgan Securities. You may proceed with your question.

Hey guys. good morning.

Hi Steve.

Are there any risks around creating the structure for this entity? How do you gauge, in this political environment, the risk of not being able to execute on this, or have your lawyers told you it's pretty iron-clad?

Yes, Steve. There are certainly process steps we will go through as we file today for Aearo Technologies, and we have to work through each of those steps. There are always decisions made along the way, so I think that's part of gaining certainty as we go, and we'll keep everybody updated. Kevin, do you want to make any comments specifically?

Yes. Certainly, while most Chapter 11 proceedings are contested, Steven. We're prepared to move forward and we believe the applicable law supports our position as we move forward into this process. And the goal, again, is to remove uncertainty to set up a more efficient and equitable process for establishing a fund to compensate claimants who are entitled to compensation as opposed to the process of continuing to litigate on a claim-by-claim basis.

Got it, helpful. One quick follow-up: how are you preparing for a potential broad pullback in demand? During COVID you removed a lot of temporary costs and were able to defend margins. What contingencies do you have this time? Will things be different, or should we expect the same playbook as COVID if there is a significant macro pullback over the next couple of quarters?

Yes, Steve, I think as you've seen, we manage into recessions and through any kind of slowdowns with a broad-based approach. We'll do what's needed given the economic conditions. As I said, we're watching how each of the market demand areas are developing, how the overall macro is developing, and what's going on in the global economic outlook. We'll take actions as required, and it will be reflected in what we do in our factories, how we manage our commercial businesses, and how we operate the company. We'll keep you updated as we get a better view.

Excellent. Thanks.

Our next question comes from Nigel Coe with Wolfe Research. You may proceed with your question.

Thanks. Good morning, everyone.

Good morning, Nigel.

Yeah, thanks. Just wanted to go back to the bankruptcy filing. So when you put Aearo into Chapter 11, do you move EBITDA in that business? How does that work?

Yes, Nigel. Depending on how the bankruptcy proceeding goes, the plan will be to deconsolidate that entity, but the overall revenue and earnings are immaterial in the grand scheme of things.

Okay. Okay. We'll move offline there. And then, I mean, there is controversy around the structure and those appeals and the congressional bickering about it. But how contingent is the Healthcare separation on a successful filing for Aearo? I mean, is one contingent on the other? So can you still go ahead and separate Healthcare even if the filing for Aearo is unresolved?

Yes, Nigel. We did announce both actions today. They result from separate strategies and decisions. The Healthcare spin reflected our active portfolio management: we consider where to invest, where acquisitions make sense, and how to maximize value, and that analysis drove the decision to spin Healthcare. We have invested in strategies to create a stronger Healthcare company; it is well positioned to succeed and has a great future as a standalone company. The steps related to Combat Arms Litigation stemmed primarily from the bellwether trial, which produced highly variable results. We believe it would take years to litigate those claims, so rather than pursue a costly, drawn-out process, we chose a better, fairer, and more efficient resolution. They happened to be announced the same day, but they are based on distinct strategies. Both actions position us well: the spin creates greater opportunity, and the Combat Arms actions provide more certainty.

Thanks Mike. And then if I can just follow up. We get a lot of questions from investors around, obviously, the $1 billion is what you put in initially. But obviously, the plaintiffs will be at a much, much higher level. So as the scheme and the structure is approved, how does that gap get bridged between the $1 billion you putting in and, obviously, the plaintiffs are at a much, much higher level? How does that get resolved?

Based on what we're doing, there will be a separate process. Kevin can explain how that will proceed. The court that has responsibility for these proceedings will oversee that process. As I said, we are committed to a fund based on what we believe is an appropriate analysis by an external expert firm. Kevin can outline the steps of that process and how it will be resolved.

Yes. As part of the Chapter 11 proceeding, there will be a claims estimation process where the court oversees that process. And we believe that the $1 billion that we have committed based on the external analysis is sufficient to fund a trust for those claimants who are entitled to compensation. The proceedings will be the subject of expert reports overseen by the court. The claimants will be represented as well. And we believe this is a number that is required, the funding agreement. If necessary, 3M is prepared to provide additional funding to resolve this matter at the end of the process.

Thanks, Kevin. Very helpful.

Our next question comes from Joe Ritchie with Goldman Sachs. You may proceed with your question.

Thanks. Good morning, everyone and congrats on both announcements.

Good morning, Joe.

Good morning, Joe.

Yes. My question is for Kevin, actually, because this is all fairly new to us. I'm just curious. Like, is there some kind of likelihood that the plaintiffs will come back and want their lawsuits to be heard outside of bankruptcy court?

So, once the Chapter 11 filing is made, there's an automatic stay as to the debtor entity, which, in this case, is Aearo Technologies. We are also asking for that automatic stay to be extended to 3M. We are funding, according to the terms of the funding, indemnification agreement. We're committing to fund the trust to help the court set up a mechanism for compensation for those claimants entitled to compensation. We're providing that funding through Aearo. So we think we are entitled to as 3M and hope the court will extend the stay of litigation to 3M, and that would put a stay on the existing litigation in state and federal court.

Got it. Okay. That's helpful. And then can you guys maybe just provide a little bit more color around the timing, like how this structure actually helps to expedite the timing in getting the resolution with the potential payments?

Yes. So the Chapter 11 case was just filed this morning. The court has not set a schedule yet. There have been a wide range of duration for other Chapter 11 filings to resolve litigation matters. We're hoping to work through the process and resolve the matter as quickly as possible. We hope that all parties will share that goal and move it along as expeditiously as the court's procedures permit. We'll certainly provide updates as the case progresses. And if you think about this in context, we've participated in the MDL process for the past three years, taking 16 cases through bellwether trials. We're now at the next step, which is to pair 1,500 cases for trials around the country while we await the outcomes of our appeals. So as compared to the process ahead to litigate each of these cases on a case-by-case basis, we believe that the Chapter 11 proceeding will be more expeditious and certainly, will provide more clarity and a way to more efficiently and equitably provide compensation to those who are entitled to it.

Okay. Got it. Thank you very much.

Our next question comes from Julian Mitchell with Barclays. You may proceed with your question.

Hi, good morning. I wanted to clarify a couple of things on healthcare since there's been a lot of focus on Combat Arms. On the healthcare side, margins have been down for several quarters now. Monish, I know you always say that volume leverage is the main driver of margins, but at healthcare that hasn't seemed to be the case recently. When do you expect those healthcare margins to turn around? Will they be up year over year in the back half? And on healthcare, the plan is that it's levered at 3 to 3.5 times — is the plan that you take that first step, the big dividend back to the RemainCo when it spins out, and then take the second step a year later so you can start to monetize that just-under-20 percent stake? Is that the way to think about the cash from healthcare?

Yes, I think both are great questions, Julian. I'll start with the first on margins. As we told you, EBITDA margins for the second quarter were 30%. As we have talked about before, when you compare to prior periods you have to take into account the Acelity acquisition and its impact on purchase accounting, which depresses margins. That's why I would look at EBITDA, which is 30% in the second quarter. For the year 2021 we ended at 31% EBITDA. So hopefully that answers your question on that range. Do we see it continuing to improve? Absolutely. The business is doing a really nice job of managing inflation with price actions. They continue to drive productivity actions. And as volumes start to recover, which is back to your point because volumes drive the biggest leverage, as we are seeing elective procedures start to go back up and, hopefully, it doesn't get impacted by another wave of COVID, you'll start seeing that business continue to drive growth in that area. The team is quite focused on margin and on driving organizational efficiency through root cause analysis. On your second question about how the dividend works, I'll start by saying this is still 15 to 18 months away. But the way it will work at that moment in time when the spin happens, there will be a dividend payout from healthcare, which currently we are saying is going to be levered 3 to 3.5 times with positioning for rapid deleveraging because of the strong cash flow that healthcare itself generates. As part of that transaction, 3M will also retain a 19.9% equity stake in our healthcare business that we can monetize over time. The whole intent of this transaction is to be as tax efficient and tax-free, for which we will go ahead and file all the requirements needed to make it tax-free, but we are in no rush right now to sell the stake once the spin happens, and we'll monetize it over time. I think that gives us a lot more flexibility to pursue strategic options between the dividend that we get as well as the retained stake that we can monetize over time. Hope that helps, Julian.

That's great. Thanks Monish. And then maybe a sort of more reskin of operating guidance question. So if I look at the new guidance, I think it implies 270-ish of earnings per quarter in the second half. You did about 250 in Q2. I don't think FX is getting easier in the back half. Organic volumes probably not better in the second half given the macros. So just trying to understand, what do you think is getting better in that back half versus the second quarter or the first half run rate? Because you're starting out with that FX headwind, maybe there's a little bit less of that in China $0.11 COVID hit. But anything else you'd call out to drive that step-up in earnings?

Sure, Julian. I'll give you all the pieces and try to provide both sequential and year-over-year data, so apologies if it's a bit confusing. FX continues to be a pressure. As I said in my prepared remarks, FX was 5% in the third quarter and 4% for the year, so that adds additional pressure from the first half to the second half. On the positives and negatives: first, as I mentioned, China still came in with a backlog we expect to clear in the second half — you’ll see that in the third and fourth quarters. We came in $140 million down year-over-year, so there is recovery there. Second, build rates in automotive are up nearly 9% in the second half versus the first half; for the full year they are up about 5% versus our earlier expectation of 9% for the year. Demand remains strong in semiconductors, data centers and factory automation. Third, elective procedures, which were in the 85% to 90% range in the first quarter, moved up to 90% to 95%, and we expect them to return to 100% by the end of the fourth quarter. Lastly, GDP and IPI are still forecast to be up 3% to 4% — about 3% for the year versus 4% when we started the year — so they’re still projecting growth in the second half. On the downside, FX and the stubborn, evolving impacts of COVID continue to affect us. Supply chain and logistics pressures persist. We expect higher inflation in the second half, but we are managing that with price actions to offset it. We’re watching consumer behavior closely because broad-based inflation is affecting purchasing power. We’re also seeing softening in consumer electronics, especially TVs; smartphones are expected to be up about 7% to 8% half-over-half but down about 4% year-over-year. And, as Mike noted, geopolitical uncertainties, particularly in Europe, are a factor. With all that said, the team is doing a great job managing through this. We are focused on doing whatever it takes to deliver for our customers, which is our top priority, while exercising cost discipline and continuing to invest in growth, productivity and sustainability. Long term, these trends will play out and there are strong investment opportunities for the new 3M and for Healthcare, so we’re committed to investing for the long run. Sorry for the long answer, but I wanted to make sure you got the data points.

Thank you for the details.

Our next question comes from Josh Pokrzywinski with Morgan Stanley. You may proceed with your question.

Hi, good morning everyone. Thanks for all the details this morning.

Good morning Josh.

Just a question on maybe kind of the perspective capital allocation strategy for RemainCo. You said kind of through the separation, no real change, but just given kind of the focus of the liabilities and the cash coming out with healthcare free cash flow margins being pretty high. Any change in the way folks should think about something like a dividend policy going forward?

Yes, Josh, I'd start by saying we're continuing to focus on driving growth and our capital allocation priorities reflect that, and they will remain unchanged. First and foremost, it's about investing in our business. It's about paying an attractive dividend, which remains a high priority for us, looking at strategic M&A that can add value and deliver greater opportunities for the company, and returning capital to shareholders through share repurchases. We continue to see that as our set of priorities going forward. When you look at the new 3M, it will be a very strong, focused, well-capitalized business, a leader in highly attractive markets, as we've discussed on the call. We'll have tremendous cash flow in that business and a strong balance sheet. And as Monish just highlighted, with the proceeds from the spin and the 19.9% retained stake that we can monetize over time, it will get stronger. So we will be well positioned to continue to execute those capital priorities and continue to create value.

Got it. That's helpful. And then, I know the historical kind of framework on 3M or the portfolio rationale was that a lot of the IP was domiciled at corporate. I think there are some more diverse assets in Health Care, maybe than some of the other industrial businesses. But are there any dissynergies by virtue of either some of the IP or manufacturing process sourcing that kind of gets separated there when Health Care leaves?

Yes, Josh, we've long talked about the benefit our businesses have in leveraging the fundamental strengths of 3M. And they've certainly been important to building the Healthcare business, the technologies that we have are unique and differentiated technologies, our manufacturing capabilities, our global capabilities and our brands. And Healthcare as you touched on, with our portfolio strategies, we've built a stronger Healthcare business. We've done it with organic investments and sometimes leveraging some of those key technologies. We've added acquisitions, significant part of the business now with Acelity and M*Modal coming in as part of the business. We've also stepped in to really focus that business through the divestiture of drug delivery and soon the separation of the food safety business. So, all of that has positioned Healthcare not only to be a strong stand-alone company, well positioned to be able to execute those same strategies moving forward. There's always some connectivity to the technologies manufacturing at 3M. The connection between Healthcare and the rest of the company is more limited than the three businesses that will make up new 3M. We'll be able to manage that separation well, we think, especially with the focus that Healthcare has on those specific markets. So it's been an important part of building it. We think it's well positioned with what we can do in the spin to be able to take it forward.

Josh, I just want to add a few more things to what Mike just said. We're going to have dedicated teams that are going to drive the separation. Also, just looking at precedent of other spins publicly, plus some of the experience that we have had with our divestitures in the healthcare space, we believe the separation cost is going to be somewhere in the range of $1 billion to $1.5 billion that will get played out over time. Some of it will start now and some of it will play out over the next 24 months. But again, it's quite early in the process. The teams are starting to get ramped up as we get and learn more, we'll definitely keep you posted.

That’s great. All the best guys.

Our next question comes from Deane Dray with RBC Capital Markets. Please proceed with your question.

Thank you. Good morning, everyone.

Good morning, Deane.

A couple of cleanup questions here. First, just to clarify, is the Board considering any other divestitures or spins, or will RemainCo's 3M portfolio remain as is going forward?

Yes, Deane, our portfolio strategy is continual. We're always evaluating where we want to change our portfolio, adding through M&A and managing to optimize value. That's something I will continue as we go forward. I talk a lot about the new 3M. We believe the three businesses that will make up that new 3M company will be strong and well positioned for success in their markets. They will leverage the technology at the heart of 3M and the company's fundamental strengths. It will be a continual process and an important strategy. I think our portfolio strategy really complements what we do with innovation. We're driving innovation, creating new solutions for customers, and building new businesses. At the same time, portfolio management ensures we're looking broadly at where we're creating the greatest value and how we need to think differently about it. That is not going to change as we execute the spin.

Got it. And then just want to understand, is there a scenario similar to what you're doing in combat arms for PFAS, where you would consider a similar bankruptcy structure. Is this related to this, it wasn't clear in the filing today. Maybe this is a technical question for Kevin. But are you – is this being filed under a 105(a) bankruptcy structure? Because it certainly sounds that because that would require all of those sign-ups and approvals, which would suggest there's going to be an extended process there to get to the finish line?

Yes, Deane maybe I'll take the PFAS part of that question, and then I'll let Kevin answer the 105(a) question. So, on PFAS, we continue to be focused on practically managing our environmental stewardship and stepping up and following through on our commitments there. We're vigorously defending ourselves in the cases that we have with PFAS. And we're looking to reasonably resolve, remediate where we can. We expect PFAS is going to play out over years. And I would probably leave it at we're well advised of our options.

Yes. So we believe that 105(a) does provide authority as well as other provisions of the bankruptcy code, given the Aero technologies liabilities that are included. And so our filings are being completed today, and those will spell out the various bases for seeking the relief that we've asked the Chapter 11 court to provide.

Will you also pledge your insurance assets?

Our insurance assets are part of the funds we can tap into to fund the trust. Those assets, along with other company assets, will be provided to fund the trust. One point to clarify: the filing includes the Combat Arms liabilities and some legacy, discontinued Aearo Technologies respirator and mask claims. Some of those claims involve asbestos exposure and are addressed under 524(g) of the code.

Got it. That’s really helpful. Thank you.

Our next question comes from Nicole DeBlase with Deutsche Bank. You may proceed with your question.

Yes. Thanks. Good morning, guys.

Good morning, Nicole.

Just maybe a couple of questions on the business. I mean, looking at inventory, how would you categorize inventory in the channel versus what's ideal? And I think probably the biggest question would be around how you would view your consumer inventory?

Yes. Nicole, it's something we watch closely always. It's something that gives us a good indication of the sell-through of each of our businesses. There are certainly some areas where we've seen some inventory build-up related to COVID lockdowns, for example. We've added and built inventory ahead of some ERP go-live actions that we're taking. When we look at channel inventory, it's been relatively stable. It's had to react to the same kind of supply chain challenges that we are seeing and to disruptions in supply and logistics. So it's a little more dynamic than usual, but pretty well aligned with what we're seeing in terms of demand. We're watching consumers closely. There was elevated inventory in the channel as part of that, which has been publicly discussed and that retail leaders are working through. We're seeing some of that as well. We still see strong sell-out point-of-sale demand, so it's something we're watching closely. And again, I would say it's more dynamic, but maybe except for retail inventory, pretty well in line with expected demand.

Got it. Thank you. And then just a follow-up on price cost. So some kind of key commodities have started to come down. At what point could that start to impact your margin positively. Like is that as soon as could impact the back half of 2022, or is that more of a 2023 margin dynamic at this stage?

Yes, Nicole. And we watch this closely. As you know, we have exposure to multiple feedstocks, luckily not one of them is overly material. You look at polypropylene, you look at resin, you look at logistics, airfreight costs, et cetera. The thing that we haven't yet seen is sustained reduction. So you get data points like you've seen the data points of oil come down. But how that translates down to the feedstocks because we don't buy crude oil is going to play itself out. So that's what we are watching. And so I don't know whether it impacts 2022 or 2023. But what we do see still right now is there's broad-based inflation all around that is getting pushed down as tiers are getting involved. And as I told you, we have updated our guidance to 750 to 850 of inflation for the year, which is higher than what we thought coming into the year. But at the same time, we are managing that inflation through price. And I think what we'll have to watch is to supply chains get sustainably improved versus one or two data points.

Understand. You shall pass it on.

Our last question comes from Brett Linzey with Mizuho Securities. You may proceed with your question.

Hi. Good morning, all and congrats on today's announcements.

Thanks, Brett.

I appreciate the color on the separation cost, the $1 billion to $1.5 billion. But I was hoping you could provide some color, insight on what the go-forward standup corporate structure costs will be for the two entities?

Yes, Brett. I'll give you some benchmark data. For the healthcare business we have a placeholder: a benchmark stand‑up cost of approximately $100 million, which is the public company cost for a company of that size. Similarly, right now we have penciled in about 1.5% of revenue for New 3M as incremental or stranded costs. As Mike and I have said several times, we are focused on organizational efficiency. We are still early in the process and will keep working this down. We have time until the spin is complete, so we will continue to be as efficient as possible to allow both companies to grow above the macro, achieve margin expansion, and generate strong cash.

Okay. Got it. Thanks. And just one last one on the Bellevue facility. So you reached the agreement in early July on some of the actions, the new commitments. Could you just provide us with an update how that facility production is ramping? And are you still partnering with a third party there? Are you going to get back to kind of full run rate in terms of your internal sourcing strategy by the end of the year?

Yes. Brett, we are in the process of restarting the manufacturing operations there. It will take several weeks to complete. We reached an agreement and were pleased with the cooperation from the local authorities to resolve the matters and move forward. We will be ramping up to full production soon. We are staying in touch with our customers to keep them informed of our timelines, and we are currently in the middle of that ramp-up.

Okay. Great. Best of luck.

That concludes the question-and-answer portion of our conference call. I will now turn the call back over to Mike Roman for some closing comments.

In summary, we are positioning 3M for the future to create more opportunity and greater certainty. There will be two world-class, well-capitalized public companies. We will work to efficiently and equitably resolve our Combat Arms litigation, and we will maintain our relentless focus on delivering for our customers and shareholders. We remain focused on driving growth and margin expansion and generating strong cash flow. We're excited about the new opportunities to apply 3M Science to life. Thank you for joining us.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.