3M Company (NYSE: MMM) — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; fourth-quarter results are also summarized below. The filing was signed February 9, 2017. 3M is a diversified global technology and manufacturing company with five segments: Industrial; Safety and Graphics; Health Care; Electronics and Energy; and Consumer. Approximately 59.5% of 2016 sales came from outside the United States.
Financial performance and key metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Net sales | $30.109 billion | $30.274 billion |
| Operating income | $7.223 billion; 24.0% margin | $6.946 billion; 22.9% margin |
| Net income attributable to 3M | $5.050 billion | $4.833 billion |
| Diluted EPS | $8.16 | $7.58 |
| Operating cash flow | $6.662 billion | $6.420 billion |
| Free cash flow (non-GAAP) | $5.242 billion | $4.959 billion |
| Capital expenditures | $1.420 billion | $1.461 billion |
| Total debt | $11.650 billion | $10.797 billion |
| Cash, cash equivalents and marketable securities | $2.695 billion | $1.925 billion |
| Net debt (non-GAAP) | $8.955 billion | $8.872 billion |
Cost of sales was 49.9% of revenue, versus 50.9% in 2015. The effective tax rate was 28.3%, compared with 29.1%. Working capital was $5.507 billion, up from $3.868 billion. The debt-to-total-capital ratio rose to 53% from 48%. Moody’s rating was A1 with a stable outlook; S&P’s was AA− with a stable outlook.
Fourth quarter: Sales were $7.329 billion, up 0.4% year over year; organic local-currency sales rose 1.6% (volume +1.5%, price +0.1%). Operating margin was 22.7%, versus 20.5%. Net income attributable to 3M was $1.155 billion and diluted EPS was $1.88, compared with $1.038 billion and $1.66 in fourth-quarter 2015.
Changes versus comparable periods
- Full-year sales declined 0.5%; organic local-currency sales decreased 0.1%, with volume down 0.8% and selling prices up 0.7%. Acquisitions added 1.2%, divestitures reduced sales 0.4%, and currency translation reduced sales 1.2%.
- Diluted EPS increased 7.7%. Management attributed improvement to operating benefits, lower pension and postretirement expense, restructuring productivity, lower raw-material costs, a lower tax rate, and fewer shares outstanding. Currency reduced EPS by $0.14; lower organic volume and utilization were headwinds.
- Electronics and Energy was the weakest segment: sales fell 8.1% in reported dollars and 7.5% organically in local currency. Health Care grew 3.5% organically, Safety and Graphics 2.2%, Consumer 1.9%, and Industrial was flat.
- Operating margin improved 1.1 percentage points. The comparison benefited from the absence of 2015 restructuring charges, lower pension costs, price/raw-material benefits, and restructuring-related productivity; organic volume and utilization, strategic investments, currency, and legal costs partly offset these gains.
- Operating cash flow increased $242 million, primarily from higher net income and lower cash taxes, partly offset by higher pension contributions. 2016 share repurchases were $3.753 billion, below the more than $5 billion repurchased in each of 2015 and 2014.
Outlook, capital allocation and management commentary
- Management expected 2017 capital spending of approximately $1.3–$1.5 billion and gross share repurchases of $2.5–$4.5 billion. The expected 2017 effective tax rate was approximately 28–29%.
- 3M expected 2017 global defined-benefit pension and postretirement contributions of $300–$500 million. Benefit expense before settlements and other special items was expected to increase approximately $74 million pre-tax from 2016.
- Two announced divestitures—the identity management business and safety prescription eyewear business—were expected to generate an approximately $500 million pre-tax gain in 2017. The identity management sale was expected to close in the first half of 2017.
- Management’s capital priorities were investment in organic growth, including R&D and capital expenditures; complementary acquisitions; and shareholder returns through dividends and repurchases. The company continued to add leverage as part of its capital-structure strategy.
- The board declared a first-quarter 2017 dividend of $1.175 per share, a 6% increase. The 2016 dividend was $4.44 per share.
- Research, development and related expense was $1.735 billion in 2016. 3M described investment in disruptive innovation and a phased worldwide ERP implementation as strategic priorities.
Risks, contingencies and unusual items
- Litigation: 3M disclosed respirator-mask/asbestos liabilities of $595 million, excluding Aearo accruals of $19 million. The primary accrual estimates claims extending toward 2050; the company said it could not estimate the amount by which claims might exceed the accrual. Insurance receivables for this litigation were $4 million after a $35 million receivable reversal following an arbitration decision.
- Product claims: Approximately 1,260 Bair Hugger patient-warming lawsuits were pending at year-end, versus approximately 122 a year earlier. 3M recorded no liability, stating loss was not probable and estimable. Three Lava Ultimate dental-material lawsuits were also pending.
- Environmental/PFC matters: 3M described ongoing remediation and litigation concerning perfluorinated compounds, including PFOA/PFOS and AFFF-related claims. Recorded environmental remediation liabilities were $38 million with $11 million of related insurance receivables; other environmental liabilities were $29 million with $15 million of related receivables. For certain ongoing matters, the company could not estimate possible losses beyond accruals.
- Other legal items: 3M recorded costs associated with an unfavorable insurance-arbitration ruling, TransWeb and Andover matters, and respirator/asbestos accruals. It paid TransWeb $27 million in March 2016; the Andover litigation was resolved for an amount described as not material. Management cautioned that future adverse rulings or settlements could materially affect results or cash flows in a particular period.
- Tax and accounting: Early adoption of share-based payment accounting rules produced a $184 million 2016 tax benefit. The company also disclosed an immaterial correction to prior-period balance-sheet amounts related to respirator/asbestos liabilities; it said there was no impact on previously presented operating results or cash flows.
- Other exposures: Risks include foreign-exchange movements (about 60% of revenue was international), competitive pricing and customer demand, raw-material supply and cost changes, pension funding and discount rates, cybersecurity and ERP implementation, regulatory changes, and acquisition integration. Moody’s downgraded 3M from Aa3 to A1 in March 2016, citing the planned increase in leverage.
Most important facts for investors to verify
- Whether organic sales and volume recover, particularly in Electronics and Energy and in challenged regional markets.
- How much of 2016 earnings growth reflects recurring operations versus the $184 million share-based-payment tax benefit, divestiture gains, restructuring comparisons, and reduced share count.
- Whether higher leverage, debt maturities, interest expense, and the capital-return program remain consistent with management’s credit-rating objectives.
- Developments in asbestos/respirator, Bair Hugger, PFC/environmental and other litigation, including potential losses beyond recorded accruals and insurance recoveries.
- Completion and realized gain from the announced divestitures, and delivery of the 2017 capital spending, pension contribution, tax-rate, and repurchase expectations.