3M Company — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. The interim financial statements are unaudited; the independent accountant performed a review, not an audit. 3M is a diversified global manufacturer with five operating segments.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $7.686B | $8.134B | $15.264B | $15.965B |
| Operating income | $1.840B | $1.856B | $3.570B | $3.572B |
| Operating margin | 23.9% | 22.8% | 23.4% | 22.4% |
| Net income attributable to 3M | $1.300B | $1.267B | $2.499B | $2.474B |
| Diluted EPS | $2.02 | $1.91 | $3.87 | $3.70 |
| Operating cash flow | Not separately stated | Not separately stated | $2.418B | $2.732B |
| Free cash flow | Not separately stated | Not separately stated | $1.757B | $2.098B |
Q2 organic local-currency sales grew 1.8% (volume +0.8%, price +1.0%); currency translation reduced reported sales 7.3%. For the six months, organic local-currency sales grew 2.5% (volume +1.5%, price +1.0%), while translation reduced sales 6.9%. Currency effects, including hedging, reduced pretax income by an estimated $110 million in Q2 and $200 million year to date.
Margin improvement reflected higher selling prices, lower raw-material costs, productivity and volume leverage. In Q2, higher pension and postretirement expense reduced margins by 0.6 percentage points; strategic investment and first-year acquisitions reduced them by a further 0.3 and 0.1 points, respectively. For the six months, pension expense reduced margins by 0.6 points and strategic investment by 0.2 points.
Balance sheet, cash flow and capital allocation
- At June 30, cash and cash equivalents were $2.983B; current and noncurrent marketable securities totaled $515M. Total debt was $8.517B, including $8.431B of long-term debt. Net debt, as defined by 3M, was $5.019B, up from $3.486B at year-end 2014.
- Debt to total capital rose to 39% from 34% at year-end. The $2.25B revolving credit facility was undrawn; the company reported covenant coverage of approximately 68:1 against a 3:1 minimum.
- Working capital was $8.336B, versus $5.767B at December 31, 2014. Year-to-date operating cash flow declined $314M, reflecting higher cash taxes and pension contributions, as well as increased working-capital requirements. Free-cash-flow conversion was 70%, compared with 85%.
- Year-to-date capital spending was $661M; share repurchases were $2.581B and dividends paid were $1.298B. 3M issued approximately $1.9B of euro-denominated debt in May.
Material changes and segment performance
- Reported sales declined in every segment in Q2, principally due to currency translation. Organic local-currency sales grew in four of five segments; Electronics and Energy declined 3.0%.
- Safety and Graphics led Q2 organic local-currency growth at 4.9%; Health Care and Consumer each grew 3.4%, and Industrial grew 1.4%. Segment operating income rose in Safety and Graphics, Health Care and Consumer, but fell in Industrial and Electronics and Energy.
- For the first six months, organic local-currency sales grew in all five segments. Electronics and Energy’s year-to-date operating income increased 7.7% despite lower reported sales; Health Care operating income declined 1.5%.
- Q2 diluted EPS rose to $2.02 from $1.91, supported by operational benefits, a 3.2% reduction in diluted weighted-average shares and a lower tax rate. For the six months, diluted EPS rose to $3.87 from $3.70; the lower share count helped, while currency reduced pretax earnings by an estimated $200M.
Outlook, transactions and risks
- Management expected a 2015 effective tax rate of 28.5%–29.5%, assuming reinstatement of the U.S. research and development credit; capital spending of approximately $1.4B–$1.6B; and gross 2015 share repurchases of $4B–$5B.
- Expected 2015 cash contributions to global defined-benefit pension and postretirement plans were approximately $200M. Management forecast 2015 plan expense to increase about $210M pretax versus 2014, primarily due to lower discount rates and new mortality tables.
- 3M had agreed to acquire Polypore’s Separations Media business for approximately $1.0B and Capital Safety for $2.5B enterprise value, including assumption of about $0.7B of debt. Both deals were expected to close in Q3 2015, subject to regulatory and customary conditions. The company stated it had sufficient liquidity to fund them.
- Management cited a mixed global economy, strong U.S. dollar, uneven regional demand and foreign-exchange volatility. Other stated risks include competitive and pricing pressures, raw-material supply and cost changes, acquisition integration, productivity execution, cybersecurity and ERP implementation, credit-rating pressure, and legal, environmental and regulatory outcomes. Moody’s rating was Aa3 with a negative outlook; S&P’s was AA- with a stable outlook.
- Contingencies include respirator/asbestos claims: approximately 2,150 claimants were pending at June 30; recorded liability was $139M, the low end of an unquantifiable range, with $41M of related insurance receivables. Aearo-related accruals were an additional $22M. Environmental liabilities were $65M in total ($26M remediation and $39M other environmental), with $26M of associated insurance receivables.
- Other notable matters include the Minnesota natural-resources lawsuit over PFC contamination; the TransWeb patent/antitrust judgment of approximately $26M, which 3M appealed and for which it recorded no liability; and a French customer claim involving alleged defective electrical splices, with an expert estimating damages above €100M. 3M stated the expert opinion was not dispositive.
Key facts for investors to verify
- Whether organic growth and pricing can offset continued currency headwinds, particularly in EMEA and Latin America/Canada, and weakness in Electronics and Energy.
- Whether operating-margin gains persist as pension costs rise and strategic investments and acquisitions affect margins; confirm the assumptions behind the $210M pension-expense increase.
- Cash generation and working-capital trends, including the decline in operating cash flow and free-cash-flow conversion, against planned capital spending, dividends and buybacks.
- Funding, closing conditions and integration performance for the Polypore and Capital Safety acquisitions, and the effect of additional leverage on credit ratings.
- Developments in asbestos, PFC/environmental and product-liability matters, including potential losses beyond recorded accruals and collection of insurance recoveries.
- Whether the U.S. R&D credit is reinstated and whether the projected tax-rate range is achieved.