3M Company — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. 3M is a diversified global manufacturer operating in Safety and Industrial, Transportation and Electronics, Health Care, and Consumer. Results were materially affected by the COVID-19 pandemic and related demand and supply-chain disruption.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $7.176B | $8.171B | $15.251B | $16.034B |
| Operating income | $1.740B | $1.702B | $3.403B | $2.838B |
| Operating margin, GAAP | 24.3% | 20.8% | 22.3% | 17.7% |
| Operating margin, adjusted | 19.6% | 20.8% | 20.2% | 21.1% |
| Net income attributable to 3M | $1.290B | $1.127B | $2.582B | $2.018B |
| Diluted EPS, GAAP | $2.22 | $1.92 | $4.44 | $3.44 |
| Diluted EPS, adjusted | $1.78 | $2.13 | $3.93 | $4.35 |
- Sales fell 12.2% in Q2 and 4.9% for the first half; organic local-currency sales declined 13.1% and 6.5%, respectively.
- GAAP Q2 operating income includes a $387M pre-tax gain on the drug-delivery divestiture. Adjusted Q2 diluted EPS decreased 16.4% year over year; adjusted first-half diluted EPS decreased 9.7%. GAAP comparisons also reflect significant litigation charges in 2019.
- Q2 segment sales declined 20.9% in Transportation and Electronics and 9.2% in Safety and Industrial; Health Care was down 0.4% and Consumer down 6.2%. For the first half, Health Care sales rose 10.1%, largely reflecting Acelity and M*Modal acquisitions, while organic local-currency sales declined.
- Q2 demand was strong for personal safety products and in selected home-improvement, cleaning, semiconductor, data-center, and biopharma markets. Weakness included oral care, automotive and aerospace, automotive aftermarket, and general industrial applications.
Cash flow, liquidity and debt
- First-half operating cash flow was $3.118B, versus $2.710B in 2019. Capital expenditures were $711M, producing defined free cash flow of $2.407B versus $1.898B; free-cash-flow conversion was 93% versus 94%.
- At June 30, cash and cash equivalents were $4.219B and marketable securities were $281M. Current assets were $14.106B and current liabilities $7.282B.
- Total debt was $20.762B, compared with $20.313B at year-end 2019. Net debt, as defined by 3M, was $16.262B, down from $17.819B. The increase in cash included proceeds from $1.75B of notes issued in March.
- 3M reported an A1 Moody’s rating and A+ S&P rating, both with negative outlooks. Its $3.0B and $1.25B U.S. revolving credit facilities were undrawn; covenant EBITDA-to-interest coverage was about 18:1 against a 3:1 minimum.
- Dividends paid in the first half totaled $1.693B. The quarterly dividend was $1.47 per share; share repurchases were suspended in late March after $366M of first-half purchases.
Outlook, risks and unusual items
- Management did not provide a 2020 earnings or effective-tax-rate range, citing the uncertainty, duration, and recovery timing of COVID-19. It said the pandemic’s eventual effect on results and financial condition could not be predicted.
- Full-year capital spending was expected to be about $1.4B, reduced from the prior $1.6B–$1.8B estimate, while retaining investment to expand respirator production. 3M also reported just over $200M in anticipated U.S. government funding under the Defense Production Act for N95 capacity expansion, with final terms still being completed.
- COVID-19 increased demand for respirators but depressed many end markets, disrupted supply chains, and contributed to unabsorbed manufacturing costs and restructuring. Q2 actions included $58M of pandemic-related restructuring charges affecting about 400 positions and $55M of divestiture-related restructuring charges affecting about 1,300 positions; most related activity was expected to finish by Q2 2021.
- 3M completed the sale of substantially all of its drug-delivery business in May for $617M in consideration, including cash, an interest-bearing security, and a 17% interest in the buyer. The $387M pre-tax gain materially boosted reported Q2 operating income.
- Key contingencies include PFAS litigation, environmental remediation and regulatory matters; respirator-mask/asbestos claims; and Combat Arms earplug litigation. Recorded June 30 liabilities included $382M for other environmental liabilities, $581M for respirator-mask/asbestos claims (excluding Aearo), and $21M for Aearo-related claims. 3M said it could not estimate potential losses above certain accruals. The filing disclosed 730 AFFF lawsuits and approximately 2,853 Combat Arms earplug lawsuits representing about 11,650 claimants.
- Other risks include the ongoing COVID-19 impact, foreign-exchange exposure, litigation and regulatory outcomes, and an internal investigation of China-based travel, funding, and recordkeeping practices disclosed to the DOJ and SEC.
Most important facts for investors to verify
- Whether organic sales and margins recover as pandemic-related restrictions and market disruptions ease, especially in transportation, oral care, and industrial end markets.
- How much reported earnings depended on the one-time drug-delivery gain, and whether adjusted margins and EPS trends improve.
- Whether cash generation, debt levels, credit ratings, and the dividend remain sustainable under prolonged economic weakness.
- Developments in PFAS environmental obligations and litigation, including the adequacy of recorded accruals and the potential for additional remediation or regulatory costs.
- Final terms and execution of government-supported respirator capacity expansion, and whether planned capital spending remains near $1.4B.