3M CO quarterly report, Q2 FY2017

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3M Company (3M) — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods unless noted. 3M is a diversified global manufacturer reporting through Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer segments. Segment reporting was reorganized in Q1 2017; prior-period segment figures were recast. Interim financial statements were reviewed, not audited.

Financial performance

  • Q2 revenue: $7.810 billion, up 1.9%; organic local-currency sales grew 3.5%. Six-month revenue was $15.495 billion, up 2.8%, with organic local-currency growth of 4.0%.
  • Q2 earnings: Operating income was $2.184 billion, up 17.1%; operating margin was 28.0% versus 24.4%. Net income attributable to 3M was $1.583 billion versus $1.291 billion; diluted EPS was $2.58 versus $2.08. Six-month operating income was $3.958 billion, up 8.3%, on a 25.5% margin versus 24.2%; net income was $2.906 billion versus $2.566 billion, and diluted EPS was $4.74 versus $4.13.
  • Nonrecurring and investment effects: Q2 included a $461 million pretax gain on business sales. Compared with the prior year, divestiture impacts net of lost operating income added $451 million pretax, while incremental strategic investments reduced pretax earnings by $178 million. For the first six months, the corresponding amounts were a $490 million gain, $438 million net divestiture benefit, and $314 million of incremental strategic investments.
  • Cash flow: Six-month operating cash flow was $2.630 billion, up from $2.545 billion. Capital expenditures were $589 million, producing reported free cash flow of $2.041 billion versus $1.908 billion; free-cash-flow conversion was 70% versus 74%. Increased receivables and inventories absorbed cash.
  • Liquidity and debt: At June 30, cash and cash equivalents were $2.654 billion and marketable securities totaled $157 million. Total debt was $11.301 billion and net debt was $8.490 billion, down from $8.955 billion at year-end 2016. Working capital was $6.944 billion, up $1.437 billion since year-end. The $3.75 billion revolving credit facility was undrawn; commercial paper outstanding was about $50 million. Cash, cash equivalents and marketable securities totaled $2.811 billion, of which approximately $2.7 billion was held abroad.
  • Returns and investment: Six-month dividends paid were $1.403 billion; dividends declared were $1.175 per share per quarter. Share repurchases were $1.184 billion. 3M expected 2017 repurchases of $2.0–$3.5 billion and capital spending of $1.3–$1.5 billion.

Material changes and segment trends

  • Organic local-currency sales grew in every segment in Q2. Electronics and Energy led with 8.4% growth; Industrial grew 3.8%, Safety and Graphics 3.2%, Health Care 2.5%, and Consumer 0.7%.
  • Electronics and Energy showed strong improvement, with Q2 sales up 7.5% overall and operating income up 38.8%. Management cited stronger consumer-electronics demand and increased inclusion in OEM platforms.
  • Consumer sales were nearly flat in Q2 and down 0.1% for the first half; U.S. stationery and office supplies remained weak amid channel inventory adjustments.
  • Safety and Graphics operating income rose sharply because of divestiture gains, while sales declined 0.9% in Q2 as divestitures reduced reported sales. Industrial, Health Care, and Consumer operating income declined year over year in Q2.
  • Q2 sales growth was partly offset by divestitures (1.0 percentage point) and currency translation (0.6 point). Currency effects, including hedging, reduced pretax income by an estimated $44 million in Q2 and $79 million in the first half.
  • Cost of sales rose to 51.2% of sales in Q2 from 49.5%; management cited portfolio and footprint charges, currency, higher pension expense, and lower selling prices, partly offset by raw-material cost deflation.

Outlook, management commentary and risks

  • Management expected a 2017 effective tax rate of 26%–27%, global pension and postretirement contributions of $300–$500 million, and second-half portfolio/footprint actions and strategic investments with an estimated $0.20–$0.25 per diluted-share impact. The filing text provided here does not state a full-year consolidated sales or EPS guidance figure.
  • 3M expected the $2.0 billion Scott Safety acquisition to close in the second half of 2017, subject to customary conditions and approvals. The company also agreed to sell its electronic monitoring business for $200 million, net of cash sold, with an expected pretax gain of about $100 million, subject to closing conditions.
  • Q2 restructuring actions affected about 1,300 positions and generated a $99 million pretax charge; completion was expected by the end of 2018. The company also recorded about $40 million of long-lived asset impairments in Electronics and Energy during the first half.
  • Key exposures include foreign-currency movements, global economic and competitive conditions, raw-material supply and pricing, pension-market risks, cybersecurity and ERP implementation, and legal and environmental proceedings. 3M noted that its ongoing move toward a more leveraged capital structure could affect its credit ratings; ratings were AA- from S&P and A1 from Moody’s, both with stable outlooks.
  • Environmental matters include PFC/PFAS-related remediation and drinking-water litigation. Recorded environmental liabilities were $36 million for remediation and $28 million for other environmental liabilities; the company said it could not estimate possible losses above established accruals for certain ongoing matters. Respirator/asbestos liabilities were accrued at $561 million, plus $18 million for Aearo-related claims; the company could not estimate the amount by which these liabilities might exceed accruals. About 2,600 plaintiffs had brought Bair Hugger warming-system claims, for which no liability was recorded because loss was not considered probable and estimable.
  • Other notable matters include a Department of Labor investigation of the company’s pension plan and continuing tax examinations. The IRS had not proposed significant unreserved adjustments as of June 30; 3M anticipated a decrease in unrecognized tax benefits over the next 12 months.

Important facts for investors to verify

  • How much of reported earnings and margin growth reflects the $461 million Q2 divestiture gain, versus underlying organic growth, productivity, and strategic spending.
  • Whether second-half strategic investments and portfolio actions remain within management’s per-share impact estimate, and whether expected savings or growth benefits materialize.
  • Cash generation and working-capital trends, particularly receivables and inventory, alongside planned repurchases, dividends, capital spending, and the Scott Safety acquisition.
  • Progress and potential financial exposure from PFC/PFAS, respirator/asbestos, and Bair Hugger litigation, including any changes to accruals or estimates of possible loss.
  • Whether foreign-cash availability, debt levels, and planned capital deployment affect credit ratings or the cost of funding.