3M Company — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. The interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Business context and financial performance
3M is a diversified global manufacturer and technology company reporting across Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer. It operates in more than 70 countries and derives approximately 60% of revenue outside the United States.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $8,152 | $8,172 | $24,820 | $23,667 |
| Operating income | $2,016 | $2,008 | $5,424 | $5,903 |
| Operating margin | 24.7% | 24.6% | 21.9% | 24.9% |
| Net income attributable to 3M | $1,543 | $1,429 | $4,002 | $4,335 |
| Diluted EPS | $2.58 | $2.33 | $6.61 | $7.08 |
| Operating cash flow | Not separately provided | Not separately provided | $4,181 | $4,380 |
| Capital expenditures | Not separately provided | Not separately provided | $1,046 | $914 |
| Free cash flow | Not separately provided | Not separately provided | $3,135 | $3,466 |
Q3 diluted EPS rose 11% year over year, while nine-month diluted EPS fell 7%. Excluding the $897 million Minnesota natural-resource-damages (NRD) charge and $217 million tax measurement-period adjustment, nine-month diluted EPS was $8.13, up 15% year over year; adjusted operating margin was 25.5% and adjusted effective tax rate was 20.0%. These are company-presented non-GAAP measures, not substitutes for GAAP results.
Q3 organic local-currency sales increased 1.3%; total sales declined 0.2%, reflecting divestitures and currency translation. For the first nine months, organic local-currency sales increased 3.3% and total sales grew 4.9%. In Q3, Safety and Graphics sales rose 7.0% (including Scott Safety acquisition contribution); Health Care fell 2.8%, Electronics and Energy fell 4.8% (including the Communication Markets divestiture), Consumer fell 3.4%, and Industrial was flat.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $3.185 billion; cash, cash equivalents and marketable securities totaled $3.550 billion.
- Total debt was $14.846 billion, up $897 million from year-end 2017; net debt was $11.296 billion, up $1.503 billion. Long-term debt was $13.539 billion and short-term borrowings/current debt were $1.307 billion.
- Current assets were $14.419 billion and current liabilities $7.336 billion, producing reported working capital of $7.083 billion. The $3.75 billion revolving credit facility was undrawn; the company reported a covenant EBITDA-to-interest ratio of approximately 21:1 against a 3:1 minimum. No commercial paper was outstanding at quarter-end.
- Nine-month financing cash use was $4.549 billion, including $3.601 billion of share repurchases and $2.406 billion of dividends. The company repurchased $3.6 billion of shares in the period and had approximately $1.5 billion remaining under its authorization.
Material changes and unusual items
- The $897 million pre-tax Minnesota NRD resolution charge was recorded in Q1 2018. Under the settlement, 3M agreed to provide an $850 million grant to a Minnesota water-quality and sustainability fund.
- The June sale of substantially all of the Communication Markets Division generated $772 million cash proceeds and a $494 million pre-tax gain. A related $105 million restructuring charge covered approximately 900 positions; remaining actions were expected to be largely completed by the first half of 2019. A Germany-based services sale remained pending.
- In Q3, cost of sales was 51.0% of revenue versus 49.7% a year earlier. For the first nine months, SG&A was elevated by the NRD and restructuring charges, and the reported operating margin included the NRD charge. Excluding that charge, management said nine-month operating margin increased to 25.5% from 24.9%.
- 3M issued $2.25 billion of medium-term notes in September, with maturities from 2021 to 2048, and repaid $450 million of notes in August. Interest expense increased year over year, reflecting higher U.S. average debt and borrowing costs.
- Accounting changes included adoption of the new revenue standard, with less than $2 million added to opening retained earnings and no material current-period revenue impact. Pension-cost presentation was retrospectively changed; it reclassified non-service costs out of operating income without changing prior-period pre-tax or net income. Segment reporting was also revised for the new organizational alignment.
Outlook, management commentary and risks
- Management estimated a 2018 effective tax rate of approximately 23%–25%. The estimate remained subject to discrete items and finalization of TCJA accounting.
- Expected 2018 capital spending was approximately $1.6 billion; expected gross share repurchases were $4.0–$5.0 billion. Management expected to contribute up to $400 million to global defined-benefit pension and postretirement plans.
- Management cited organic growth, pricing and productivity as earnings supports, partly offset by higher raw-material costs, foreign exchange, and remaining stranded costs after the Communication Markets sale. Drug Delivery sales were weak; management expected that business to stabilize in 2019.
- Material contingencies include PFAS-related environmental matters and litigation, respirator/asbestos claims, and Bair Hugger patient-warming-system product-liability cases. The respirator litigation includes an appealed 2018 jury award of approximately $2 million compensatory damages and $63 million punitive damages; 3M said it did not consider liability probable and estimable. The company recorded a $600 million accrual for its respirator/asbestos matters, excluding Aearo, and a separate $29 million Aearo accrual.
- 3M reported 75 putative class and other AFFF-related environmental lawsuits as of September 30, 2018. The company stated that it could not estimate possible losses or ranges for several environmental cases, including PFAS matters, where it had not recorded a liability because loss was not considered probable and estimable. Environmental liabilities recorded were $29 million for remediation and $69 million for other environmental obligations, with $8 million in related insurance receivables.
- Other cited risks include global economic and geopolitical conditions, tariffs and trade restrictions, competition and customer demand, currency and raw-material volatility, product-development execution, acquisition integration, ERP implementation and cybersecurity, pension-market exposure, and adverse legal or regulatory outcomes.
Important facts for investors to verify
- Reconcile GAAP nine-month earnings and margins with management’s adjusted figures, particularly the $897 million NRD charge, $217 million TCJA adjustment, and Communication Markets gain and restructuring effects.
- Track organic sales, pricing, currency and acquisition/divestiture contributions by segment; assess whether Q3 weakness in Health Care and Consumer persists and whether Scott Safety integration supports margins.
- Monitor cash conversion and working capital: operating cash flow and free cash flow declined year over year, while receivables and inventory increased; verify the effect of ERP deployment and the NRD settlement.
- Assess debt and capital returns against cash generation: net debt increased, while substantial repurchases and dividends continued; verify the pace of planned buybacks and capital spending.
- Follow developments in PFAS/AFFF, respirator/asbestos and Bair Hugger litigation, including appeals, regulatory actions, settlements, insurance recoveries and potential changes to accruals.
- Confirm the final 2018 tax rate, TCJA measurement-period accounting, and expected lease-accounting adoption impacts beginning in 2019; the filing said the lease standard’s impact was still being assessed.