3M Company — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. 3M is a diversified global manufacturer operating across Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer segments.
Key financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $8,390 | $7,810 | $16,668 | $15,495 |
| Operating income | $2,401 | $2,153 | $3,408 | $3,895 |
| Operating margin | 28.6% | 27.6% | 20.4% | 25.1% |
| Net income attributable to 3M | $1,857 | $1,583 | $2,459 | $2,906 |
| Diluted EPS | $3.07 | $2.58 | $4.04 | $4.74 |
| Effective tax rate | 20.8% | 26.0% | 25.6% | 25.0% |
- Q2 sales grew 7.4%; organic local-currency sales increased 5.6%, with acquisitions contributing 2.1 percentage points and currency translation 1.0 point, partly offset by divestitures (-1.3 points).
- Q2 diluted EPS increased 19% year over year. For the first half, reported diluted EPS declined about 15%; excluding the $897 million Minnesota natural-resource-damages charge and the $217 million TCJA measurement-period tax adjustment, adjusted diluted EPS was $5.56, up 17% year over year. These adjusted figures are non-GAAP.
- First-half operating cash flow was $2,042, down $588 year over year; capital spending was $669 and free cash flow was $1,373, versus $2,041 in the prior-year period. Free cash flow conversion was 56%, versus 70%.
- At June 30, cash and cash equivalents were $2,801; current marketable securities were $385. Total debt was $14,519 and net debt (company-defined, non-GAAP) was $11,307. The undrawn revolving credit facility was $3.75 billion; the company reported covenant EBITDA-to-interest coverage of approximately 23:1.
- Cash dividends paid in the first half were $1,612; 3M repurchased $2,537 of shares. Total shareholders’ equity was $10,365, down from $11,563 at year-end 2017.
Material changes versus prior period
- All five business segments recorded higher Q2 sales. Safety and Graphics grew 15.8% and Electronics and Energy 3.6%; segment sales comparisons reflect acquisitions and divestitures as well as organic growth.
- Q2 operating margin improved 1.0 percentage point. First-half reported margin fell 4.7 points, primarily reflecting the Minnesota NRD charge; excluding that charge, first-half margin was 25.8%, versus 25.1% in 2017.
- In June, 3M sold substantially all of its Communication Markets Division to Corning for $772 million cash proceeds and recorded a $494 million pre-tax gain. The business had annual sales of about $400 million. A German services portion sale, approximately $30 million, remained pending.
- The sale prompted a $105 million Q2 restructuring charge affecting about 900 positions, with remaining actions expected to be largely completed in the first half of 2019.
- Q2 results also benefited from the Communication Markets gain net of related restructuring, adding $0.48 to diluted EPS. In Q2 2017, 3M had recorded a $457 million gain on sale of its identity management business, which affects year-over-year comparisons.
Outlook, commentary, risks and unusual items
- Management estimated a 2018 effective tax rate of approximately 23% to 25%. It expected capital spending of $1.5 billion to $1.8 billion, share repurchases of $4.0 billion to $5.0 billion, and global pension and postretirement contributions of $300 million to $500 million. No full-year EPS guidance is clearly provided in the filing text.
- Management cited organic growth, selling-price increases and productivity as positive factors; higher raw-material costs partly offset them. It continued investment in R&D and a multi-year business-transformation and ERP implementation.
- The Minnesota PFAS natural-resource-damages lawsuit was resolved for an $850 million grant to the state; 3M recorded a $897 million pre-tax charge including legal fees and related obligations. The filing describes additional PFAS regulatory activity and litigation, including 70 putative class and other AFFF-related lawsuits as of June 30. 3M states that losses for certain matters are not probable and estimable or cannot be reasonably estimated beyond recorded accruals.
- Respirator/asbestos claims numbered about 2,260 individual claimants. The related 3M accrual, excluding Aearo, was $631 million after a $56 million first-half increase; the company said the potential excess loss cannot be estimated. A Kentucky jury awarded approximately $2 million compensatory and $63 million punitive damages in an April respirator case; 3M planned to appeal and said liability was not probable and estimable.
- Other notable legal matters include approximately 4,626 Bair Hugger plaintiffs; a May 2018 federal bellwether jury verdict favored 3M, while related litigation continues. The DOL indicated in June it did not intend further action on its pension-plan investigation.
- Key risks include global economic and trade conditions, competition and customer demand, foreign exchange, input costs and supply, acquisition/divestiture execution, productivity and ERP implementation, cybersecurity, pension funding, tax-law changes, and legal and environmental proceedings. Management reported disclosure controls were effective; the independent accountant’s interim review found no material modifications needed, but was not an audit opinion.
Important facts for investors to verify
- How much of Q2 and first-half earnings and margin performance is recurring versus attributable to divestiture gains, restructuring, and legal charges?
- What are the eventual cash timing and possible range of exposure for PFAS, respirator/asbestos, and other product-liability matters, including outcomes not estimable at filing?
- Whether organic growth, pricing and productivity can offset raw-material inflation and divested-business sales, especially in segments with uneven operating-income comparisons.
- How the planned $4.0–$5.0 billion 2018 repurchases, dividends, capital spending and pension contributions affect debt and liquidity; net debt increased $1.514 billion from year-end.
- How remaining TCJA accounting, tax audits and the projected 23%–25% full-year tax rate develop, and whether pending divestiture proceeds or transition arrangements affect results.