3M Company — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; filed August 2, 2016. 3M is a diversified global manufacturer reporting five business segments. Segment figures were recast for a product-line reporting change effective in Q1 2016. The interim statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $7.662B | $7.686B | $15.071B | $15.264B |
| Operating income | $1.866B | $1.840B | $3.654B | $3.570B |
| Net income attributable to 3M | $1.291B | $1.300B | $2.566B | $2.499B |
| Diluted EPS | $2.08 | $2.02 | $4.13 | $3.87 |
| Operating margin | 24.4% | 23.9% | 24.2% | 23.4% |
- Sales declined 0.3% in Q2 and 1.3% for the first half. Organic local-currency sales declined 0.2% and 0.6%, respectively; currency translation reduced sales by 1.5 and 2.2 percentage points.
- Q2 operating income rose 1.4%, while net income attributable to 3M slipped about 0.7%. First-half operating income rose 2.3% and net income rose about 2.7%. Lower diluted share counts supported EPS growth.
- Management attributed margin improvement primarily to higher selling prices, lower raw-material costs, lower pension and postretirement expense, and restructuring-related productivity. Organic volume declines, lower utilization, foreign exchange, strategic investments, and legal and other items were offsets. Raw-material cost deflation was about 3.5% year over year.
- First-half operating cash flow was $2.545B, versus $2.418B; capital expenditures were $637M. Company-defined free cash flow was $1.908B, versus $1.757B, and free-cash-flow conversion was 74%, versus 70%.
- At June 30, cash and cash equivalents were $1.688B and marketable securities totaled $191M. Total debt was $11.749B; company-defined net debt was $9.870B, up from $8.872B at year-end 2015. Debt was 50% of total capital, versus 48% at year-end.
- Working capital was $4.182B, up $314M from year-end. The $3.75B revolving credit facility was undrawn; the company reported an approximately 51-to-1 EBITDA-to-interest ratio against a 3-to-1 minimum. Credit ratings were AA- (S&P) and A1 (Moody’s), both stable.
Segment and period comparisons
- Q2: Health Care sales rose 3.0% and Safety and Graphics rose 4.7%; Consumer rose 1.7%. Industrial was nearly flat, while Electronics and Energy sales fell 10.0% and operating income fell 18.1%.
- Electronics and Energy faced weak consumer-electronics demand and elevated channel inventories; management expected these challenges to persist into the second half of 2016. Segment actions reduced its Q2 operating margin by about 0.8 percentage points.
- Health Care delivered 4.9% organic local-currency sales growth in Q2; its operating margin was 32.7%. Safety and Graphics benefited from Capital Safety acquisition sales, while its organic local-currency growth was 2.3%.
- For the first half, Electronics and Energy sales fell 11.8%, including a 10.4% organic local-currency decline. Health Care and Safety and Graphics grew 3.5% and 3.8%, respectively.
- Acquisitions contributed 1.9 percentage points to Q2 company sales growth and 2.0 points for the first half; divestitures reduced growth by 0.5 points in both periods. First-quarter divestitures generated a $40M pretax gain. No material business combination closed in the first half.
Outlook, management commentary, and risks
- Management revised its 2016 effective tax-rate outlook to 29.0%–29.5%, from 29.5%–30.5%, citing additional net benefits from early adoption of share-based payment accounting guidance. That adoption generated tax benefits of $59M in Q2 and $140M in the first half.
- Expected 2016 capital spending was $1.3B–$1.5B; expected gross share repurchases were $4B–$6B. The Board’s $10B repurchase authorization had about $8.7B remaining at June 30. The quarterly dividend was $1.11 per share.
- Management expected restructuring actions affecting about 1,700 positions to produce approximately $130M of pretax savings in 2016. Global pension and postretirement contributions were expected to total $200M–$400M for 2016. A change in benefit-cost estimation methodology reduced estimated 2016 annual benefit cost by about $180M; management also expected pension and postretirement expense to decline about $320M pretax versus 2015.
- Key operating pressures included a stronger U.S. dollar, mixed global growth, soft U.S. manufacturing, and weakness in electronics end markets. Management reported that currency effects, including hedging, reduced pretax income by about $40M in Q2 and $90M in the first half.
- Legal and environmental exposures: Respirator-mask/asbestos accruals were $147M, excluding Aearo, and Aearo-related accruals were $20M; the company could not estimate potential losses above these amounts. The company reversed $35M of asbestos-related insurance receivables after a final arbitration decision and reported $4M of remaining related insurance receivables. Environmental liabilities were $47M for remediation and $33M for other environmental matters, with related receivables of $11M and $15M, respectively. PFOA/PFOS proceedings and remediation, the Minnesota natural-resources lawsuit, and product litigation—including Bair Hugger claims—remain risks; some losses were not considered probable and estimable.
- Other notable items included a $27M payment to resolve the TransWeb judgment in March 2016 and an agreement resolving EDF litigation in June; the latter’s confidential terms, after insurance, were not material according to the company. The filing identifies global economic, currency, competitive, raw-material, pension, regulatory, litigation, cybersecurity, and ERP implementation risks.
Important facts for investors to verify
- Whether organic sales and electronics demand stabilize, especially in Asia Pacific, and whether channel inventory normalizes as management anticipated.
- Whether pricing, raw-material savings, restructuring, and lower benefit costs sustain margins despite volume and currency headwinds.
- Whether debt-funded capital returns remain consistent with the company’s leverage objectives, credit ratings, and cash generation.
- Whether the revised tax-rate outlook, repurchase and capital-spending plans, and pension contribution estimates are achieved.
- How asbestos, PFOA/PFOS, Bair Hugger, and other legal and environmental matters develop, including potential costs beyond recorded accruals and the recoverability of insurance.