3M Company — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless stated otherwise. 3M is a diversified global manufacturer and technology company. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Key financial results
| Metric | Q1 2019 | Q1 2018 | Change / context |
|---|---|---|---|
| Net sales | $7,863 | $8,278 | Down 5.0%; organic local-currency sales down 1.1%, with foreign currency translation reducing sales 3.4% |
| Operating income | $1,136 | $1,007 | Up 12.8% reported; includes significant litigation charges in both periods |
| Operating margin | 14.4% | 12.2% | Up 2.2 percentage points reported; excluding significant litigation charges, 21.4% versus 23.0% |
| Net income attributable to 3M | $891 | $602 | Up 48.0% |
| Diluted EPS | $1.51 | $0.98 | Up 54.1% reported; adjusted for significant litigation charges and the 2018 TCJA measurement-period adjustment, $2.23 versus $2.50, down 10.8% |
| Operating cash flow | $1,048 | $143 | Increase primarily reflected lower litigation charges and payment timing |
| Capital expenditures | $391 | $304 | Free cash flow was $657 versus negative $161; conversion was 74% versus negative 27% |
| Cash, cash equivalents and marketable securities | $3,523 | $3,270 at Dec. 31, 2018 | About $3.2 billion held by foreign subsidiaries and $300 million in the U.S. |
| Total debt | $16,370 | $14,622 at Dec. 31, 2018 | Net debt was $12,847, up $1,495 from year-end |
Business trends and changes
- Sales declines were concentrated in Industrial (down 6.6%), Safety and Graphics (down 4.2%), and Electronics and Energy (down 11.8%). Health Care sales were up 0.3%, while Consumer sales fell 1.9%.
- Management cited slowing end markets in China, automotive and electronics, customer channel inventory adjustments, and weaker productivity, particularly in industrial-related businesses in Asia Pacific and the U.S. Organic local-currency sales fell 3.6% in Asia Pacific.
- Reported earnings benefited from comparison with Q1 2018, which included $897 million of litigation charges and a $217 million tax expense related to the Tax Cuts and Jobs Act. Q1 2019 included $548 million of significant litigation-related charges.
- Q1 2019 litigation charges included a $313 million pre-tax increase to respirator mask/asbestos liabilities and a $235 million increase to other environmental liabilities. Excluding significant litigation charges, operating margin and diluted EPS declined year over year.
- 3M acquired M*Modal’s healthcare technology business in February for $704 million net of cash acquired and assumed approximately $251 million of debt. The business contributed about $50 million of sales and a $20 million operating loss, including transaction and integration costs.
- Total debt rose following $2.25 billion of medium-term note issuances. 3M repurchased $701 million of stock and paid $830 million in dividends. Shares outstanding fell 3.9% on a weighted-average diluted basis.
Liquidity, outlook and management commentary
- Management described cash generation, capital-markets access and liquidity as strong. The $3.75 billion revolving credit facility was undrawn; the company reported an EBITDA-to-interest covenant ratio of approximately 24 to 1 against a minimum of 3 to 1. No commercial paper was outstanding at quarter-end.
- Management estimated a 2019 effective tax rate of approximately 20%–22%, capital spending of $1.6 billion–$1.7 billion, and gross share repurchases of $2.0 billion–$4.0 billion. It expected approximately $200 million of 2019 pension and postretirement contributions.
- In April 2019, management began restructuring and other actions expected to affect about 2,000 positions worldwide, with an anticipated pre-tax charge of approximately $150 million during the remainder of 2019. The company linked the actions to a slower-than-expected 2019.
- Management cited business transformation, including a phased global ERP implementation, as a productivity initiative. It noted weaker-than-expected productivity in Q1 and higher raw-material costs, partly offset by selling-price increases and transformation benefits.
Risks, contingencies and unusual items
- Respirator litigation: 3M agreed in principle to settle a substantial majority of coal mine dust lawsuits in Kentucky and West Virginia for $340 million, including a prior jury verdict. The company recorded $954 million for its respirator mask/asbestos liabilities, excluding Aearo, and said it could not estimate the amount by which future liability might exceed the accrual.
- PFAS and environmental matters: Other environmental liabilities totaled $292 million, with $33 million of related insurance receivables. The company cited regulatory uncertainty, evolving cleanup standards and litigation; it could not estimate potential losses above established accruals. It settled a Water Authority case for $35 million and agreed to settle the Lake Elmo case for less than $5 million.
- Other product litigation: The filing describes ongoing Bair Hugger patient-warming-system cases and approximately 1,700 claimants in Combat Arms earplug litigation. 3M reported no liability for Bair Hugger matters because it considered loss not probable and estimable at that time.
- Tax matters: Federal, state and foreign tax audits are ongoing. Unrecognized tax benefits that would affect the effective tax rate were $679 million; the company said the possible change over the next 12 months could be significant but could not estimate a range.
- Foreign currency and markets: A stronger U.S. dollar and weaker demand affected results. The company also identified economic, trade, competitive, raw-material, productivity, cybersecurity, pension, legal and regulatory risks.
- Iran disclosure: 3M disclosed historical indirect sales to an Iran government party through a foreign subsidiary, totaling approximately $8.4 million in revenue and $1.6 million in net income. Shipments stopped in November 2018; the company submitted initial voluntary self-disclosures to OFAC in April 2019 and said it intended to cooperate.
Most important facts for investors to verify
- Whether organic sales and productivity improve in the markets management identified as weak, especially China, automotive and electronics.
- How much of the gap between reported and adjusted earnings reflects litigation charges, and whether underlying margins recover from the adjusted Q1 decline.
- Developments in PFAS, respirator and other product-liability matters, including settlement payments, accrual adequacy and potential additional exposure.
- Execution and cost of the 2,000-position restructuring, global ERP/business transformation, and M*Modal integration.
- Debt, cash deployment and capital returns against the stated 2019 ranges for capital spending and share repurchases.
- The outcome of tax audits and the OFAC review of the disclosed Iran-related sales.