3M Company — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparative period is Q1 2011 unless otherwise noted. 3M is a diversified global manufacturer organized into six operating segments. Interim financial statements are unaudited; the independent accountant conducted a review, not a full audit.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 / comparison |
|---|---|---|
| Net sales | $7.486 billion | $7.311 billion; up 2.4% |
| Operating income / margin | $1.634 billion / 21.8% | $1.578 billion / 21.6% |
| Net income attributable to 3M | $1.125 billion | $1.081 billion |
| Diluted EPS | $1.59 | $1.49 |
| Operating cash flow | $828 million | $733 million |
| Capital expenditures | $261 million | $231 million |
| Free cash flow (company-defined, non-GAAP) | $567 million | $502 million |
| Cash and marketable securities | $4.494 billion at March 31 | $4.576 billion at December 31, 2011 |
| Total debt / net debt | $5.174 billion / $680 million at March 31 | $5.166 billion / $590 million at December 31, 2011 |
| Working capital | $7.445 billion at March 31 | $6.799 billion at December 31, 2011 |
Revenue growth comprised 1.8 percentage points from organic local-currency sales (0.1 point volume and 1.7 points pricing), 1.5 points from acquisitions, partly offset by 0.9 point from currency translation. Operating margin improved 0.2 percentage point: pricing net of raw-material effects and productivity helped, while higher benefit costs and currency effects weighed on results. The effective tax rate was 28.8%, versus 28.6%.
Operating cash flow rose despite $337 million of pension and postretirement contributions, compared with $61 million in Q1 2011. Cash generation was partly used for $410 million of dividends and $524 million of treasury-stock purchases; proceeds from employee stock plans offset part of repurchases. Cash and marketable securities exceeded total debt by $680 million, using the company’s net-debt definition. Debt was 24% of total capital, and credit ratings were AA- (S&P) and Aa2 (Moody’s), both stable.
Material changes and segment performance
- Industrial and Transportation: Sales $2.660 billion, up 8.6%; operating income $600 million, up 16.2%; margin 22.5%, versus 21.1%. Growth was broad, led by aerospace, industrial abrasives and automotive; acquisitions contributed.
- Health Care: Sales $1.280 billion, up 2.0%; operating income $402 million, up 9.0%; margin 31.4%, versus 29.4%.
- Consumer and Office: Sales $1.043 billion, up 4.3%; operating income $234 million, up 8.8%; margin 22.4%, versus 21.5%. Acquisitions, including GPI, supported sales.
- Safety, Security and Protection Services: Sales $981 million, up 5.5%; operating income $231 million, up 16.3%; margin 23.6%, versus 21.4%.
- Display and Graphics: Sales $832 million, down 11.8%; operating income $163 million, down 29.2%; margin 19.6%, versus 24.4%. Optical systems sales fell 28%, primarily on lower LCD-TV film volumes.
- Electro and Communications: Sales $808 million, down 3.4%; operating income $168 million, down 5.7%; margin 20.8%, versus 21.3%. Weak consumer-electronics demand and lower telecommunications sales were cited.
Geographically, sales grew 6.3% in the U.S., 8.4% in Latin America/Canada and 0.1% in Europe/Middle East/Africa; Asia Pacific declined 1.9%. 3M estimated currency effects, including hedging, reduced Q1 net income by about $26 million. Share count declined year over year, supporting EPS growth alongside higher net income.
Outlook, commentary and notable items
- Management expected 2012 sales growth and related incremental income, productivity improvements, pricing above raw-material inflation and other benefits to more than offset expected headwinds. No specific full-year sales-growth or EPS target is stated in the supplied filing text.
- Management expected a 2012 effective tax rate of approximately 29.5%, compared with 27.8% in 2011, and pension/postretirement expense to rise about $89 million pre-tax (approximately $0.09 per diluted share) year over year. Currency was also expected to weigh on earnings.
- Capital spending was forecast at approximately $1.3–$1.5 billion for 2012. Planned 2012 pension and postretirement contributions were approximately $1 billion, including about $600 million in the first half; U.S. pension contributions were discretionary, not subject to a required minimum in 2012.
- Management anticipated below-trend China sales growth in Q2, with better growth rates in the second half. It expected an electronics-market upturn around mid-year; these statements are forward-looking.
- Q1 included approximately $0.04 per diluted share of early-retirement/restructuring costs, including a $26 million U.S. special termination-benefit charge. Management expected these actions to be neutral to full-year 2012 earnings. The voluntary program was accepted by 616 participants.
- 3M had agreed to acquire Avery Dennison’s Office and Consumer Products business for approximately $550 million, subject to adjustments and customary approvals, with completion expected in H2 2012. After quarter-end, 3M acquired CodeRyte in April 2012; the filing gives no purchase price here.
Risks, contingencies and unusual exposures
- Respirator/asbestos claims: Approximately 2,200 claimants were pending at March 31. 3M increased its Q1 reserve by $17 million; recorded liabilities were $133 million including Aearo, with $124 million of related insurance receivables. 3M could not estimate potential losses above reserves. Aearo-related liability estimates depend on allocation and indemnity arrangements, including a dispute with Cabot.
- Environmental matters: Recorded environmental remediation liabilities were $30 million, with $15 million of insurance receivables; other environmental liabilities were $70 million. PFC-related remediation and regulatory reviews continue, and additional costs or regulatory actions cannot be predicted. In Minnesota, the state and intervening parties pursue claims relating to alleged PFC impacts.
- Other litigation and compliance: A Meda AB claim seeks at least $200 million over the sale of 3M’s former European pharmaceutical business; 3M disputes the claim and says it cannot estimate a possible loss. 3M also continues cooperating with U.S. authorities on a Foreign Corrupt Practices Act investigation involving Turkey and issues reported in other countries.
- Market and liquidity risks: Key risks include global economic conditions, foreign exchange, raw-material and energy costs, competition, acquisitions and integration, pension assumptions, legal/regulatory outcomes, and information-technology security. A $5 million auction-rate-security holding remained illiquid after failed auctions dating to 2007; 3M considered it less than 1% of its securities portfolio.
Most important facts for investors to verify
- Whether sales and margin trends in Display and Graphics and Electro and Communications improved as management expected, especially the projected electronics recovery.
- Whether the expected 2012 tax rate, pension expense and approximately $1 billion plan contributions matched subsequent results.
- Whether the Avery Dennison transaction closed on expected terms and how the acquisition affected performance; assess the post-quarter CodeRyte acquisition separately.
- How asbestos, Aearo and PFC-related legal, environmental and insurance matters evolved, including any changes to reserves, recoveries or estimated exposure.
- Whether working-capital investment, repurchases, dividends and capital spending remained consistent with cash generation and liquidity plans.