3M Company — Q2 2012 Form 10-Q Summary
Business context and reporting period. 3M is a diversified global manufacturer and technology company operating through six segments: Industrial and Transportation; Health Care; Consumer and Office; Safety, Security and Protection Services; Display and Graphics; and Electro and Communications. This unaudited quarterly report covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. The independent accountant performed a review, not an audit.
Key financial results
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $7.534 billion | $7.680 billion | $15.020 billion | $14.991 billion |
| Operating income | $1.728 billion | $1.655 billion | $3.362 billion | $3.233 billion |
| Operating margin | 22.9% | 21.6% | 22.4% | 21.6% |
| Net income attributable to 3M | $1.167 billion | $1.160 billion | $2.292 billion | $2.241 billion |
| Diluted EPS | $1.66 | $1.60 | $3.25 | $3.09 |
| Effective tax rate | 30.1% | 27.1% | 29.5% | 27.8% |
- Sales drivers: Q2 sales fell 1.9%; organic local-currency sales grew 1.9%, acquisitions added 0.5%, and currency translation reduced sales 4.3%. For the first half, sales grew 0.2%, with organic local-currency growth of 1.9%, acquisitions contributing 1.0%, and currency reducing sales 2.7%.
- Profitability: Q2 operating income rose 4.4% and first-half operating income rose 4.0%. Management attributed margin improvement principally to selling-price increases, factory efficiency and cost discipline; higher pension costs partly offset these gains.
- Cash flow: First-half operating cash flow was $2.217 billion, versus $2.184 billion. Capital spending was $619 million, up from $526 million, resulting in company-defined free cash flow of $1.598 billion, down from $1.658 billion. Pension and postretirement contributions totaled $672 million, substantially more than in the prior-year half.
- Liquidity and debt: At June 30, cash, cash equivalents and marketable securities totaled $5.934 billion; total debt was $6.307 billion and net debt, as defined by 3M, was $373 million (versus $590 million at year-end 2011). Working capital was $8.381 billion. Debt was 27% of total capital, up from 25% at year-end. 3M reported AA- and Aa2 credit ratings, both with stable outlooks, and no commercial paper outstanding.
- Capital returns: First-half dividends were $820 million and treasury-stock purchases were $1.163 billion. The quarterly dividend was raised 7.3% to $0.59 per share; approximately $3.5 billion remained under the $7 billion repurchase authorization.
Material changes versus prior comparable periods
- Q2 reported sales weakened despite positive organic local-currency growth, principally because of the stronger U.S. dollar. EMEA sales declined 10.9% and Asia Pacific sales declined 2.1%; U.S. sales grew 4.0%.
- Display and Graphics was a key weakness: Q2 sales fell 9.3% and segment operating income fell 19.1%; first-half sales declined 10.5%. Management cited lower LCD-TV optical-film volumes and consumer-electronics softness.
- Health Care, Consumer and Office, and Industrial and Transportation improved operating income. Health Care posted a 32.3% Q2 operating margin; Industrial and Transportation operating income increased 13.0%.
- Higher pension expense and funding affected earnings and cash flows. The company’s total debt increased from $5.166 billion at December 31, 2011, partly reflecting $1.25 billion of medium-term notes issued in June.
- Currency effects reduced estimated net income attributable to 3M by approximately $36 million in Q2 and $62 million in the first half, including hedging impacts.
Outlook, commentary, risks and unusual items
- 3M expected a 2012 effective tax rate of approximately 29.5%, versus 27.8% in 2011, and pension and postretirement expense approximately $89 million higher pre-tax year over year (about $0.09 per diluted share). Currency was also expected to pressure earnings. Management said sales growth, productivity, pricing and other benefits should more than offset these headwinds; the filing does not provide a clear numeric full-year sales-growth or EPS target.
- Management expected 2012 capital spending of approximately $1.3–$1.5 billion and pension/postretirement contributions of approximately $1 billion. A further $200 million pension contribution was made July 2, after quarter-end. Pension contributions are discretionary for U.S. plans and may vary with funded status, tax deductibility and market conditions.
- Management anticipated improving year-on-year consumer-electronics growth in the second half, partly due to easier comparisons, while acknowledging that customer product-launch timing could affect results. Security Systems sales were weak; management continued monitoring the business for possible impairment indicators and said no interim impairment test was required at June 30.
- Q2 Western Europe manufacturing and supply-chain restructuring reduced earnings by approximately $0.03 per diluted share. Q2 insurance recoveries related to the 2011 Japan earthquake and tsunami added approximately $0.02 per diluted share. First-quarter early-retirement and restructuring costs were approximately $0.04 per diluted share; management expected these actions to be neutral to full-year 2012 earnings.
- Legal and environmental exposure: Respirator mask/asbestos reserves increased $50 million in the first half, including $33 million in Q2. Reported balances for respirator mask/asbestos liabilities and related insurance receivables were $160 million and $136 million, respectively; separate Aearo-related reserves were $29 million. 3M said potential additional exposure could not be estimated. Environmental liabilities included $28 million for remediation and $66 million for other environmental matters. The filing describes ongoing PFC litigation and remediation, a Minnesota natural-resources lawsuit, and other proceedings; several potential losses were not considered probable and estimable.
- Other notable contingencies include a Meda claim seeking at least $200 million (which 3M disputes), an Avery Dennison antitrust and patent dispute, and a continuing DOJ/SEC investigation following 3M’s voluntary disclosure of alleged improper conduct involving a subsidiary in Turkey and other countries. 3M said it could not predict the investigation’s outcome.
- Key risks identified include global economic weakness, currency movements, competitive and customer-demand changes, raw-material and energy costs or supply interruptions, execution of acquisitions and productivity initiatives, legal and regulatory proceedings, pension assumptions, and cybersecurity. Certain international cash was considered indefinitely reinvested; repatriating it for U.S. use could require U.S. taxes.
Important facts for investors to verify
- Whether organic sales momentum and expected second-half improvement in consumer electronics materialize, especially in Display and Graphics and Electro and Communications.
- How currency translation, pricing and regional demand affect reported sales and margins in subsequent quarters.
- Whether pension costs and contributions, restructuring savings, tax-rate assumptions and capital spending track management’s stated expectations.
- Developments in respirator/asbestos reserves and insurance recoveries, PFC remediation and litigation, the Meda claim, and the DOJ/SEC compliance investigation.
- Debt, cash deployment, share repurchases and dividend sustainability, including the impact of upcoming debt maturities and international cash availability.