3M Company — Form 10-Q summary
Business context and period. This unaudited quarterly report covers the quarter and nine months ended September 30, 2010, compared with the same 2009 periods. 3M is a diversified global manufacturer operating in six segments. Segment results were recast for 2010 product realignments; comparisons reflect the revised structure.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $6.874 billion | $6.193 billion | $19.953 billion | $17.001 billion |
| Operating income | $1.576 billion | $1.478 billion | $4.617 billion | $3.472 billion |
| Operating margin | 22.9% | 23.9% | 23.1% | 20.4% |
| Net income attributable to 3M | $1.106 billion | $957 million | $3.157 billion | $2.258 billion |
| Diluted EPS | $1.53 | $1.35 | $4.36 | $3.21 |
| Operating cash flow | Not separately stated for quarter | $3.543 billion | $3.897 billion |
- Q3 sales rose 11.0%, with organic volume growth of 10.8%; nine-month sales rose 17.4%, with organic volume growth of 15.7%. Q3 operating margin fell year over year, while the nine-month margin improved.
- Nine-month operating cash flow declined $354 million despite higher earnings. Increased working capital (receivables, inventory and payables) used $1.095 billion year over year; cash taxes and pension contributions were also higher.
- At September 30, cash, cash equivalents and marketable securities totaled $6.296 billion against total debt of $5.758 billion, a $538 million net cash position. Debt was 27% of total capital, versus 30% at year-end 2009. Working capital was $8.653 billion.
- Cash dividends paid in the first nine months were $1.124 billion. The quarterly dividend was raised 2.9% to $0.525 per share. Share repurchases under the authorization totaled $370 million in the first nine months; approximately $2.2 billion remained authorized.
Changes and segment developments
Growth was broad-based, especially in electronics, automotive OEM and industrial markets, and emerging economies. Asia Pacific Q3 sales increased 28% and Latin America/Canada 14%; U.S. sales rose 6%. Europe organic volume grew, but total sales declined 1% due to currency.
- Q3 sales growth was strongest in Electro and Communications (+25%), Display and Graphics (+19%) and Industrial and Transportation (+14%). Health Care grew less than 1%; Safety, Security and Protection Services sales fell 2.5%.
- Electro and Communications and Display and Graphics delivered strong profit growth. Health Care operating income fell 3.9% in Q3. Safety, Security and Protection Services operating income fell 27.8%, reflecting H1N1-related comparisons and weaker roofing granules.
- Q3 operating margin was pressured by product mix, selling-price declines and raw-material costs, partly offset by volume growth and prior restructuring savings. The comparable 2009 periods included restructuring charges; nine-month 2009 results also included a $15 million real-estate sale gain.
Outlook, commentary and risks
- Management expected Q4 2010 organic sales-volume growth to exceed economic growth, while noting tougher year-over-year comparisons. Its preliminary 2011 target was total sales growth of 11%, including a couple of percentage points from acquisitions, organic growth above economic growth, and 35% incremental operating margins on organic growth. Currency at then-current rates was expected to benefit income.
- Management forecast 2011 pension and postretirement expense to reduce earnings by about $0.30 per diluted share, and the absence of the 2010 banked-vacation benefit to reduce year-over-year comparisons by about $0.08 per share. The 2011 effective tax rate was preliminarily expected at 30% or slightly below, versus 28.5% or less for 2010.
- A possible discretionary $700 million pension contribution in late 2010 or early 2011 was conditional on discount rates and asset returns; actual funding could be materially lower. The company expected about $100 million of benefit-plan contributions in Q4 2010.
- Three October 2010 acquisitions—Arizant, Attenti and a controlling interest in Cogent—were expected to require approximately $1.4 billion of net cash outflows in Q4, including the expected purchase of Cogent’s remaining shares. Together they were expected to dilute Q4 EPS by about $0.06.
- The 2010 first quarter included a one-time, non-cash $84 million tax charge ($0.11 per diluted share) from U.S. health-care legislation. Venezuela’s currency accounting change was expected to reduce that subsidiary’s 2010 sales by about two-thirds versus 2009, without a material consolidated operating-income impact.
- Key risks include global economic conditions, currency movements, competition and pricing, raw-material availability and cost, product acceptance, acquisitions and productivity delivery, and legal and regulatory proceedings. Notable matters include the Turkey subsidiary investigation being conducted with DOJ and SEC cooperation, a French competition investigation with a decision expected in Q4, and environmental/PFC and respirator litigation. The filing reports $124 million of respirator-mask/asbestos liabilities and $119 million of related insurance receivables; estimates may change. Auction-rate securities of $6 million remained illiquid after failed auctions.
The independent accountant performed an interim review, not an audit, and reported no material modifications needed to the interim statements. Management concluded disclosure controls were effective.
Investor verification priorities
- Check whether sustained organic growth translates into margins, particularly given Q3 margin pressure and uneven segment performance.
- Track working-capital conversion and cash flow, including inventory growth, cash tax payments and pension funding.
- Verify the closing, integration, cash cost and earnings effects of the October acquisitions against management’s estimates.
- Monitor pension assumptions, any discretionary contribution, and the forecast increase in benefit expense.
- Follow developments in the Turkey and French investigations, PFC/environmental matters, and respirator litigation, including insurance recoverability and reserve adequacy.
- Assess the 2011 growth, incremental-margin, currency and tax assumptions as subsequent results and market conditions become available.