3M Company (MMM) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Amounts are in U.S. dollars; financial figures are in millions unless otherwise noted.
Business context and reporting period
3M is a diversified global manufacturer operating in Safety and Industrial, Transportation and Electronics, Health Care, and Consumer. In Q2 2019, it realigned its former five segments into four and adjusted product and customer reporting classifications; comparative segment data was recast. Management cited slower growth in China, automotive and electronics markets, especially in industrial businesses, and lower production as businesses reduced inventories.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $8,171 | $8,390 | $16,034 | $16,668 |
| Operating income | $1,702 | $2,401 | $2,838 | $3,408 |
| Operating margin | 20.8% | 28.6% | 17.7% | 20.4% |
| Net income attributable to 3M | $1,127 | $1,857 | $2,018 | $2,459 |
| Diluted EPS | $1.92 | $3.07 | $3.44 | $4.04 |
| Operating cash flow | Not separately stated | Not separately stated | $2,710 | $2,042 |
| Free cash flow | Not separately stated | Not separately stated | $1,898 | $1,373 |
Q2 sales declined 2.6% year over year; organic local-currency sales fell 0.9%, with acquisitions contributing 0.9 percentage points, divestitures subtracting 0.8 points, and currency translation subtracting 1.8 points. For the first half, sales declined 3.8%, including a 1.0% decrease in organic local-currency sales. First-half free cash flow conversion was 94%, versus 56% a year earlier.
Q2 GAAP diluted EPS fell 37.5%. Excluding the $162 million Venezuelan deconsolidation charge, adjusted Q2 EPS was $2.20, down 28.3% from the prior-year quarter. First-half adjusted EPS was $4.44, down 20.1%; these are company-defined non-GAAP measures.
At June 30, cash, cash equivalents and marketable securities totaled $3,034. Total debt was $15,806 and net debt, a non-GAAP measure, was $12,772. The $3.75 billion revolving credit facility was undrawn; the company reported an EBITDA-to-interest ratio of approximately 20:1 against a 3:1 minimum. Current assets were $14,051 and current liabilities were $7,265.
Material changes versus comparable periods
- Safety and Industrial sales fell 9.0% in Q2 and 8.8% in the first half; Transportation and Electronics sales fell 2.9% and 4.7%, respectively. Health Care sales rose 5.8% in Q2, partly reflecting M*Modal, while Consumer sales were nearly flat.
- Operating margin declined amid weaker organic sales, lower production and inventory reductions, higher raw-material costs, and the absence of the prior-year Communication Markets divestiture gain. Q2 2018 included a $494 million pre-tax divestiture gain; related 2018 restructuring charges were $105 million.
- First-half operating cash flow increased $668 million, which management attributed primarily to lower year-over-year litigation charges and the timing of related payments. Capital spending rose to $812 million from $669 million.
- Total debt increased $1.184 billion from year-end 2018. 3M issued $2.25 billion of medium-term notes in February and repaid $625 million of notes in June; no commercial paper was outstanding at quarter-end.
Outlook, management commentary, risks and unusual items
- Management estimated a 2019 effective tax rate of approximately 20%–22%, capital spending of $1.6–$1.7 billion, gross share repurchases of $1.0–$1.5 billion, and approximately $200 million of pension and postretirement contributions. The filing provides no explicit full-year revenue or EPS guidance in the supplied text.
- In response to a slower-than-expected 2019, 3M approved restructuring actions affecting approximately 2,000 positions and recorded a $148 million Q2 pre-tax charge. Completion was expected largely through Q1 2020.
- 3M ceased consolidating its Venezuelan subsidiary as of May 31, 2019, citing loss of control amid economic instability, unrest and sustained lack of demand. The change generated a $162 million pre-tax charge, including foreign-currency translation losses.
- 3M acquired M*Modal in February for approximately $704 million net of acquired cash and assumed debt. The acquired business contributed about $75 million of Q2 sales and a $15 million operating loss, including transaction and integration costs. Acelity/KCI acquisition was pending, estimated at approximately $4.6 billion plus about $2.5 billion of debt and related items; expected closing was Q4 2019, subject to approvals and other conditions.
- Legal exposures remain significant. 3M accrued $935 million for respirator mask/asbestos liabilities (excluding Aearo) and $251 million for other environmental liabilities, including PFAS-related matters, at June 30. The company stated it could not estimate possible losses above these accruals. A $340 million settlement in principle covered a substantial majority of certain coal-mine-dust respirator lawsuits. Numerous PFAS-related proceedings and claims remain pending.
- 3M reported voluntarily disclosing potential releases of certain materials from its Decatur, Alabama site and incorrect pollutant values in some discharge reports to regulators. It also disclosed a July 2019 congressional document request concerning PFAS and a separate internal investigation into China-related travel, funding and recordkeeping that it voluntarily reported to the DOJ and SEC; outcomes were uncertain.
- Other risks include weak end markets, customer inventory behavior, foreign exchange, raw-material costs, litigation and regulatory outcomes, credit-rating changes, pension-market exposure, and execution and cybersecurity risks associated with the multiyear ERP rollout. S&P rated 3M AA- with a negative outlook; Moody’s rated it A1 with a stable outlook.
Important facts for investors to verify
- Whether organic sales and margins stabilize, particularly in Safety and Industrial and Transportation and Electronics, and whether customer inventory reductions ease.
- How much of the year-over-year earnings decline reflects ongoing operations versus divestiture comparisons, restructuring, litigation and the Venezuela charge; compare GAAP results with the company’s non-GAAP reconciliations.
- Potential future PFAS, respirator, combat-earplug and other litigation costs, the adequacy of recorded accruals, and the timing and collectability of insurance recoveries.
- Funding and integration implications of the pending Acelity/KCI transaction, including its debt and closing conditions, alongside M*Modal’s operating performance.
- Debt, credit-rating outlook and capital returns, including whether the planned buybacks and dividend remain consistent with cash generation and investment needs.