3M Company (3M) — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. 3M is a diversified global manufacturer reporting across six business segments. Segment comparisons reflect product realignments applied to prior periods. The interim statements are unaudited; the independent accountant conducted a review, not an audit.
Financial performance and liquidity
| Metric | Q2 2011 | Six months 2011 |
|---|---|---|
| Net sales | $7.680 billion, up 14.1% | $14.991 billion, up 14.6% |
| Operating income | $1.655 billion, up 3.7% | $3.233 billion, up 6.3% |
| Operating margin | 21.6%, versus 23.7% | 21.6%, versus 23.2% |
| Net income attributable to 3M | $1.160 billion, versus $1.121 billion | $2.241 billion, versus $2.051 billion |
| Diluted EPS | $1.60, versus $1.54 | $3.09, versus $2.83 |
| Operating cash flow | Not provided separately for the quarter | $2.184 billion, versus $2.220 billion |
| Free cash flow | Not provided separately for the quarter | $1.658 billion, versus $1.883 billion |
Q2 sales growth comprised 3.2 percentage points of organic volume, 0.8 points of price, 4.0 points of acquisitions, and 6.1 points of favorable currency. Five of six segments grew sales; Display and Graphics declined 7.1%, chiefly from weaker LCD-TV optical-film demand. Operating margin fell as pension costs, currency, price/raw-material effects, and Japan disruption outweighed volume leverage. Q2 gross margin was approximately 47.4%, compared with 49.0% a year earlier, based on reported cost of sales.
At June 30, cash and cash equivalents were $3.376 billion and marketable securities were $1.555 billion. Total debt was $5.600 billion and net debt, as defined by 3M, was $669 million, up from $434 million at year-end 2010. Debt was 24% of total capital; the company reported an EBITDA-to-interest covenant ratio of approximately 37:1 against a 3:1 minimum. Working capital was $7.334 billion. No commercial paper was outstanding.
Six-month cash flow included $526 million of capital spending and $487 million of acquisitions. Operating cash flow was pressured by an $862 million working-capital investment and other net outflows. Share repurchases were $1.358 billion gross (partly offset by $753 million of treasury-stock reissuances); dividends paid were $783 million.
Changes, outlook, and management commentary
- All major geographic regions reported Q2 sales growth. Management attributed approximately 2.4 percentage points of lost organic volume to the Japan disaster, 1.3 points to optical-systems declines, and 0.3 points to the absence of prior H1N1-related sales.
- For full-year 2011, 3M expected sales above $30 billion, with organic volume growth of 6%–7.5%, currency contribution of 3.5%–4.5% (at June 30 rates), and acquisitions contributing 3%–4%. Management estimated Japan-related net impacts would reduce full-year sales growth by about 1 percentage point, operating margin by 0.3 points, and diluted EPS by 11–12 cents.
- Management expected a 2011 effective tax rate of approximately 29%. The first half of 2010 included an $84 million one-time, noncash tax charge, affecting the year-over-year tax comparison.
- Management expected 2011 pension and postretirement expense to rise by approximately $215 million pretax, or 22 cents per diluted share, versus 2010. The company was considering $400–$600 million of 2011 contributions; this was discretionary for U.S. plans. Expected 2011 capital spending was $1.3–$1.5 billion.
- 3M raised its quarterly dividend 4.8% to $0.55 per share and authorized up to $7 billion of share repurchases; approximately $5.9 billion remained under the authorization at June 30. It also announced a July agreement to acquire GPI Group, expected to close in Q4 subject to customary conditions.
Risks, contingencies, and unusual items
- Legal and environmental exposure: At June 30, recorded respirator/asbestos liabilities were $113 million, with $121 million of related insurance receivables. Environmental remediation liabilities were $30 million, with $15 million of insurance receivables; other environmental liabilities were $80 million. 3M stated that potential losses beyond reserves were not estimable for several matters, including PFC-related litigation and the Passaic River contribution claim.
- Other proceedings: The filing describes a $200 million minimum demand in a Meda acquisition-related lawsuit, age-discrimination settlements subject to approval/administration, and a continuing DOJ/SEC-related investigation into alleged conduct at a Turkish subsidiary. 3M said outcomes or potential losses could not be predicted for certain matters.
- Market and operating risks: Management cited customer inventory reductions and weak LCD-TV demand, raw-material inflation, currency movements, consumer weakness, and disruption to automotive and electronics customers following the Japan disaster. Pension costs also weighed on margins.
- Marketable securities: The $1.555 billion portfolio included $604 million of asset-backed securities. Auction-rate securities of $8 million remained illiquid after failed auctions dating to 2007.
- Other items: 3M reported no material goodwill impairment or long-lived asset impairment in the periods presented. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether full-year sales, organic-volume, margin, tax-rate, and Japan-impact expectations were achieved or subsequently revised.
- How much of sales growth came from underlying demand versus acquisitions and favorable currency, and whether LCD-related weakness persisted.
- Whether operating margins and free cash flow recovered as pension expense, raw-material costs, and working-capital investment evolved.
- Actual pension contributions and funding status, and the extent of future buybacks, dividends, capital spending, and acquisition funding.
- Developments in PFC/environmental, asbestos, commercial, and compliance matters, including potential costs beyond recorded reserves and recoveries from insurers.