3M Company — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012. Figures are in U.S. dollars; financial statement amounts are in millions except per-share data. The interim statements are unaudited and were reviewed by PwC, which reported no material modifications needed.
Business context
3M is a diversified global manufacturer organized during the period into six business segments. Management said it would realign the business into five groups, with the new structure expected to take effect in the first quarter of 2013.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $7,497 | $7,531 | $22,517 | $22,522 |
| Operating income | $1,678 | $1,581 | $5,040 | $4,814 |
| Operating margin | 22.4% | 21.0% | 22.4% | 21.4% |
| Net income attributable to 3M | $1,161 | $1,088 | $3,453 | $3,329 |
| Diluted EPS | $1.65 | $1.52 | $4.91 | $4.61 |
| Operating cash flow | — | — | $3,562 | $3,546 |
| Free cash flow | — | — | $2,585 | $2,684 |
Q3 sales fell 0.4%: organic local-currency growth of 2.2% and acquisitions adding 0.5% were more than offset by 3.1% unfavorable currency translation. Organic growth reflected roughly equal contributions from volume and pricing. For the first nine months, sales were flat; organic local-currency growth of 2.0% and acquisitions adding 0.8% were offset by 2.8% unfavorable currency translation.
Margin improvement reflected selling-price increases, lower raw-material costs, factory efficiency and cost discipline. These benefits were partly offset by higher pension and postretirement expense and currency impacts. Q3 diluted EPS also benefited by about $0.03 from fewer shares outstanding and about $0.01 from the lower effective tax rate.
Balance sheet, debt and liquidity
- At September 30, 2012, cash and cash equivalents were $3.029 billion and marketable securities were $3.389 billion. Total debt was $6.358 billion; management-defined net debt was negative $60 million, versus positive $590 million at December 31, 2011.
- Working capital was $7.899 billion, up from $6.799 billion at year-end 2011. Total assets were $34.479 billion and total equity was $18.141 billion.
- Cash from operations was $3.562 billion; capital spending was $977 million, producing management-defined free cash flow of $2.585 billion. Operating cash flow was nearly unchanged year over year despite $545 million more pension and postretirement contributions.
- 3M issued $1.25 billion of medium-term notes in June. Its $1.5 billion revolving credit facility was undrawn; no commercial paper was outstanding. The company reported an approximately 44-to-1 EBITDA-to-interest ratio against a 3.0-to-1 covenant minimum.
- Debt was 26% of total capital, compared with 25% at year-end 2011. Credit ratings were AA- (stable) at S&P and Aa2 (stable) at Moody’s.
Material changes and segment trends
- Q3 operating income rose 6.1%, while diluted EPS increased from $1.52 to $1.65. Nine-month operating income rose to $5.040 billion from $4.814 billion.
- Q3 organic local-currency sales grew in all six segments, led by Health Care (+4.3%) and Industrial and Transportation (+3.3%). Health Care operating income rose 9.0%; Industrial and Transportation rose 9.4%; Display and Graphics rose 11.2%.
- Display and Graphics remained weak over nine months: sales declined 7.1% and operating income 14.2%, primarily due to lower optical-film volumes for LCD televisions. Electro and Communications nine-month sales declined 3.4%, with softness in consumer electronics and telecommunications.
- Q3 currency effects, including hedging, reduced 3M-attributable net income by an estimated $42 million; the nine-month impact was an estimated $104 million.
- Operating cash flow was nearly flat year over year, but free cash flow declined from $2.684 billion as capital spending increased and cash contributions to benefit plans were higher.
Outlook, management commentary and notable items
- Management expected full-year 2012 effective tax expense at approximately 29.0%–29.5%, versus 27.8% in 2011. It expected pension and postretirement expense to reduce 2012 earnings by about $0.09 per diluted share year over year, including the early-retirement program.
- Management expected organic sales growth, productivity, pricing and lower raw-material costs to more than offset pension costs, currency headwinds and other negative factors. Planned 2012 capital spending was approximately $1.5 billion, and expected pension and postretirement contributions were approximately $1 billion.
- 3M raised its quarterly dividend 7.3% to $0.59 per share in 2012. It repurchased $1.490 billion of stock in the first nine months, with approximately $3.2 billion remaining under its $7 billion authorization.
- Q3 restructuring reduced diluted EPS by about $0.01; net insurance gains related to the Japan earthquake/tsunami and Thailand floods, together with evaluation of environmental matters, increased it by about $0.02. First-quarter early-retirement and restructuring costs reduced nine-month EPS by about $0.04; second-quarter Western Europe restructuring costs reduced it by about $0.03, while Japan-related insurance recoveries added about $0.02.
- The planned Avery Dennison office and consumer products acquisition was terminated in October 2012 after the parties withdrew from the regulatory approval process. In October, 3M agreed to acquire Ceradyne for approximately $860 million gross, or approximately $670 million net of specified cash, investments and debt; completion was expected in Q4, subject to conditions.
Risks, contingencies and other matters
- Respirator/asbestos claims: 3M reported approximately 2,115 individual claimants. Recorded liabilities were $163 million and related insurance receivables were $89 million. The company increased reserves during the first nine months, citing greater expected costs for serious-injury claims; it could not estimate potential losses beyond the reserves.
- Environmental exposure: Recorded environmental remediation liabilities were $29 million, with $11 million in related insurance receivables; other environmental liabilities were $62 million, with $15 million in related receivables. PFC/PFOA/PFOS matters include remediation work and litigation, including a Minnesota natural-resource damages case. For certain ongoing remediation matters, possible losses above reserves could not be estimated.
- Other legal and compliance matters: 3M was cooperating with U.S. authorities in an ongoing investigation concerning alleged bribery and bid-rigging involving its Turkey subsidiary and issues identified in other countries; the outcome was uncertain. Meda sought more than $300 million in a dispute relating to 3M’s former European pharmaceutical business. 3M also described Passaic River cleanup litigation, while stating its potential share, if any, was likely a fraction of 1% of total costs.
- Other risks cited include global economic weakness, foreign exchange movements, raw-material and energy costs, competition and pricing, acquisition integration, pension assumptions, regulatory developments, litigation, and information-technology security. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether organic growth and margin gains can offset foreign-exchange pressure and ongoing weakness in optical systems, electronics and selected markets.
- Whether full-year tax, pension-cost, contribution and capital-spending expectations were achieved, and how these affect cash generation.
- Progress and financial exposure from asbestos claims, environmental/PFC matters, and the Turkey-related compliance investigation; assess the limits of recorded reserves and insurance recoveries.
- Completion and financing of the proposed Ceradyne acquisition, and the consequences of the terminated Avery transaction.
- Whether cash, marketable securities and credit access remain sufficient as debt maturities, repurchases, dividends and acquisition plans evolve.