3M Company (MMM) — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; comparisons are with Q1 2019 unless otherwise noted. 3M is a diversified global manufacturer. It reported four segments: Safety and Industrial, Transportation and Electronics, Health Care, and Consumer. Segment and geographic reporting were revised in 2020, with prior-period figures recast.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 | Change / context |
|---|---|---|---|
| Net sales | $8.075 billion | $7.863 billion | Up 2.7%; organic local-currency sales up 0.3% |
| Operating income | $1.663 billion | $1.136 billion | Up 46.4%, primarily reflecting lower significant litigation charges |
| Operating margin, GAAP | 20.6% | 14.4% | Up 6.2 percentage points |
| Operating margin, adjusted | 20.8% | 21.3% | Down 0.5 percentage points |
| Net income attributable to 3M | $1.292 billion | $891 million | GAAP diluted EPS was $2.22 versus $1.51 |
| Adjusted diluted EPS | $2.16 | $2.22 | Down 2.7% |
| Operating cash flow | $1.213 billion | $1.048 billion | Increase attributed mainly to lower litigation charges and payment timing |
| Free cash flow | $881 million | $657 million | Free cash flow conversion was 68% versus 74% |
| Cash, cash equivalents and marketable securities | $4.511 billion | $2.494 billion at Dec. 31, 2019 | Includes cash raised through new debt issuance |
| Total debt / net debt | $22.495 billion / $17.984 billion | $20.313 billion / $17.819 billion at Dec. 31, 2019 | Net debt is a company-defined non-GAAP measure |
Q1 GAAP results were affected by a much lower net litigation charge than in 2019. In Q1 2020, 3M recorded a $17 million pretax PFAS-related charge, more than offset by a $52 million tax benefit related to resolution of the tax treatment of the Minnesota NRD settlement. Q1 2019 included $548 million of significant litigation-related pretax charges. Excluding special items, adjusted operating income was $1.678 billion versus $1.676 billion.
At March 31, current assets were $15.090 billion and current liabilities were $9.134 billion. 3M issued $1.75 billion of fixed-rate notes in March, increased commercial paper outstanding to $585 million from $150 million at year-end, and reported $3.248 billion of short-term borrowings and current debt. Its committed $3.0 billion revolving facility and $1.25 billion 364-day facility were undrawn; the covenant EBITDA-to-interest ratio was approximately 18:1 against a 3:1 minimum. Credit ratings were A1 and A+, both with negative outlooks.
3M paid $847 million in dividends and repurchased $365 million of shares before suspending repurchases in late March. The quarterly dividend was $1.47 per share.
Material changes and segment trends
- Health Care: Sales rose 21.0% to $2.103 billion, chiefly due to the M*Modal and Acelity acquisitions; organic local-currency sales increased 1.2%. Operating income was $456 million, down 1.7%, and margin fell to 21.7% from 26.7%, reflecting acquisition-related impacts and mix.
- Safety and Industrial: Sales declined 1.0% to $2.935 billion despite 2.2% organic local-currency growth. Strong personal-safety demand, including respirators, partly offset weakness across general industrial products. Operating income rose 14.0% to $726 million.
- Transportation and Electronics: Sales fell 5.0% to $2.238 billion; organic local-currency sales declined 3.0%, reflecting weaker automotive, aerospace, and commercial solutions demand. Operating income fell 7.3% to $484 million.
- Consumer: Sales grew 4.6% to $1.256 billion, with 6.1% organic local-currency growth led by home improvement and home care. Operating income increased 14.5% to $269 million.
- By geography, Americas sales increased 10.1%, while Asia Pacific declined 5.4% and EMEA declined 2.1%. U.S. sales increased 12%; China/Hong Kong sales decreased 13%.
Outlook, management commentary and risks
- COVID-19 had mixed effects: increased demand for respirators and certain cleaning, food-safety, home-improvement, and biopharma-filtration products, but weakened demand in areas including oral care, automotive, general industrial, commercial solutions, and office products. Respirator sales added just over 1 percentage point to year-over-year organic local-currency sales growth.
- Management said it could not predict the pandemic’s ultimate effect on results or financial condition and provided no full-year earnings outlook or estimated 2020 effective tax-rate range. 3M lowered expected 2020 capital spending to approximately $1.3 billion from a prior $1.6–$1.8 billion range, while including respirator-capacity expansion. It announced cost actions for Q2, including hiring freezes, reduced contract labor, and targeted furloughs.
- In April, the U.S. Department of Defense initiated a technology investment agreement involving $76 million of anticipated funding to expand N95 respirator capacity; final terms were still being completed.
- 3M agreed to sell substantially all of its drug-delivery business for approximately $650 million, subject to adjustments and closing conditions, with completion expected in Q2 2020. It expected a pretax gain of approximately $380 million. The advanced ballistic-protection business was sold in January for $86 million, with possible additional contingent consideration below $25 million.
- Significant contingencies include PFAS-related environmental, product, and regulatory matters; respirator/asbestos litigation; and Combat Arms earplug litigation. At quarter-end, recorded liabilities included $407 million for other environmental liabilities, $589 million for respirator mask/asbestos matters, and $58 million for Aearo asbestos- and silica-related claims. For several matters, 3M stated it could not estimate losses above accrued amounts. The company also disclosed ongoing regulatory inquiries concerning PFAS discharges and permits at facilities, and an FCPA investigation related to China-based marketing activity.
- Other risks include pandemic-related supply and demand disruption, foreign-exchange effects, litigation and regulatory outcomes, customer inventory changes, acquisition integration, and execution of the multi-year ERP transformation.
Investor verification priorities
- Assess whether adjusted results, particularly the 2.7% decline in adjusted diluted EPS and 0.5-point margin contraction, better indicate underlying performance than the GAAP year-over-year increase.
- Track COVID-19 demand, supply constraints, respirator capacity expansion, and the effects of cost actions on subsequent-quarter sales and margins.
- Review PFAS, respirator/asbestos, and Combat Arms litigation developments, including the adequacy of recorded accruals and the company’s inability to estimate potential excess losses.
- Monitor debt, commercial-paper usage, credit-rating outlooks, and liquidity after the March borrowing and share-repurchase suspension.
- Verify closing, proceeds, and gain recognition for the planned drug-delivery divestiture, and whether full-year capital spending remains near the revised estimate.