3M Company — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; compared with the corresponding 2018 periods. Unless stated otherwise, dollar amounts are in millions. 3M reported four business segments after realigning its former five-segment structure; comparative segment data was recast.
Financial performance
| Metric | Q3 2019 | Q3 2018 | First 9 months 2019 | First 9 months 2018 |
|---|---|---|---|---|
| Net sales | $7,991 | $8,152 | $24,025 | $24,820 |
| Operating income | $2,011 | $2,016 | $4,849 | $5,424 |
| Operating margin | 25.2% | 24.7% | 20.2% | 21.9% |
| Net income attributable to 3M | $1,583 | $1,543 | $3,601 | $4,002 |
| Diluted EPS | $2.72 | $2.58 | $6.15 | $6.61 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $4,732 | $4,181 |
| Free cash flow | Not provided for quarter | Not provided for quarter | $3,571 | $3,135 |
- Q3 sales fell 2.0% year over year; organic local-currency sales declined 1.3%. Diluted EPS rose 5.4%, while operating income was nearly unchanged. Q3 margin improvement included divestiture and property-sale gains; lower production volumes and inventory reduction pressured costs.
- For the first nine months, sales declined 3.2% and diluted EPS declined 7.0%. Excluding significant litigation-related charges, the Venezuelan deconsolidation charge and the 2018 TCJA measurement-period adjustment, adjusted diluted EPS was $7.15 versus $8.13, down 12.1%; adjusted operating margin was 22.5% versus 25.5%.
- Nine-month free-cash-flow conversion was 99%, versus 78% in 2018. Management attributed higher operating cash flow in part to the lower year-on-year litigation charges and payment timing, and to inventory-reduction actions.
- Q3 effective tax rate was 19.3% versus 21.3%; nine-month rate was 19.7% versus 24.0%.
Segments and operating trends
- Safety and Industrial: Q3 sales $2,849, down 5.7%; operating income $765, up 9.6%, with the gas-and-flame-detection divestiture gain supporting results. Nine-month sales fell 7.8% and operating income fell 25.1%.
- Transportation and Electronics: Q3 sales $2,503, down 4.4%; operating income $631, down 13.1%. Weak electronics, automotive and aerospace markets, especially in China and Asia Pacific, and channel inventory adjustments weighed on results.
- Health Care: Q3 sales $1,721, up 4.7%, including M*Modal acquisition contribution; operating income was $459, down 3.2%. Nine-month sales rose 3.3%, while operating income declined 2.5%.
- Consumer: Q3 sales $1,324, up 1.7%; operating income $308, up 2.3%. Nine-month sales were essentially flat at $3,821 and operating income was $809, down 0.3%.
- Management cited softness in China, automotive and electronics, customer channel inventory adjustments, and lower production to reduce inventories. Consumer and Health Care growth did not offset declines in Safety and Industrial and Transportation and Electronics.
Balance sheet, debt and liquidity
- At September 30, 2019, cash and cash equivalents were $7,731; marketable securities totaled $76. Total debt was $19,439, up $4,817 from year-end 2018; net debt, a company-defined non-GAAP measure, was $11,632 versus $11,352.
- Current assets were $18,020 and current liabilities $7,821. Shareholders’ equity was $10,702. Operating lease liabilities of $825 were recognized following adoption of the new lease standard.
- Cash rose substantially, largely due to debt issued ahead of the October 2019 Acelity acquisition. 3M issued $2.25 billion of notes in February and $3.25 billion in August, and drew approximately $640 million under a yen credit facility. It had no commercial paper outstanding at quarter end.
- The $3.75 billion revolving credit facility was undrawn; the company reported an EBITDA-to-interest ratio of approximately 19-to-1 against a 3-to-1 minimum covenant. Credit ratings were S&P AA- with a negative outlook and Moody’s A1 with a stable outlook.
- Nine-month capital expenditures were $1,161. Management expected full-year 2019 capital spending of approximately $1.6–$1.7 billion. 3M expected full-year share repurchases of $1.0–$1.5 billion; $8.2 billion remained under the authorization at September 30.
Guidance, notable events and risks
- Management estimated a 2019 effective tax rate of approximately 20%–21%. The filing does not provide a specific full-year sales or EPS forecast in the supplied text.
- In the second quarter, 3M announced restructuring actions affecting approximately 2,000 positions worldwide, including attrition, and recorded a $148 million pre-tax charge. Most remaining activities were expected to be completed by the first quarter of 2020.
- In October 2019, after the reporting date, 3M completed its Acelity acquisition for approximately $4.5 billion cash, subject to adjustments, and assumed approximately $2.5 billion of debt and related items. This is a subsequent event, not reflected in September 30 balances.
- In May 2019, 3M deconsolidated its Venezuelan subsidiary after concluding it no longer controlled the operation. The resulting $162 million pre-tax charge included substantial accumulated foreign-currency translation losses.
- Legal and environmental exposures are significant. 3M accrued $620 million for respirator-mask/asbestos liabilities, after increasing accruals by $337 million in the first nine months; it paid $390 million for related defense costs and settlements. The company could not estimate the amount by which this liability might exceed the accrual.
- For environmental matters, 3M recorded $241 million of “other environmental liabilities” and $20 million of non-PFAS environmental remediation liabilities. It stated it could not estimate potential losses beyond established accruals for several ongoing matters. PFAS-related litigation, regulatory reviews and investigations include claims involving AFFF, historical manufacturing and contaminated water; outcomes and potential regulatory actions remain uncertain.
- 3M disclosed a China-related internal investigation into travel, funding and record-keeping concerns that could involve the FCPA or other anti-corruption laws. It voluntarily disclosed the investigation to the DOJ and SEC and is cooperating; the outcome is not predictable.
- Other risks include global economic and trade conditions, foreign exchange, competitive pressures, raw-material availability and cost, acquisition integration, execution of restructuring and ERP transformation, cybersecurity, pension market exposure, and legal and regulatory proceedings.
Important facts for investors to verify
- Whether weak end-market demand and channel inventory adjustments persist, particularly in China, automotive and electronics, and whether organic sales stabilize.
- How much of reported margin and earnings performance depends on divestiture gains, property-sale gains, restructuring benefits and other unusual items; compare GAAP results with the company’s non-GAAP reconciliations.
- The ultimate costs and timing of PFAS, AFFF, respirator-mask/asbestos and other litigation and environmental matters, including potential amounts beyond recorded accruals and insurance recoveries.
- The impact of the Acelity acquisition on debt, interest expense, integration costs, cash generation and leverage after closing.
- Execution of planned restructuring, inventory reduction, capital spending and share repurchases, while maintaining liquidity and investment-grade credit ratings.