3M Company — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparisons are with Q1 2010 unless otherwise noted. 3M is a diversified global manufacturer reporting six business segments. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change / context |
|---|---|---|---|
| Net sales | $7.311 billion | $6.348 billion | Up 15.2%; growth included 8.9% organic volume, 3.2% acquisitions and 3.0% currency. |
| Operating income | $1.578 billion | $1.445 billion | Up 9.2%; operating margin declined to 21.6% from 22.8%. |
| Net income attributable to 3M | $1.081 billion | $930 million | Up 16.2%. |
| Diluted EPS | $1.49 | $1.29 | Up 15.5%. |
| Effective tax rate | 28.6% | 31.9% | Prior-year rate included an $84 million one-time healthcare-law tax charge. |
| Operating cash flow | $733 million | $1.082 billion | Down $349 million. |
| Free cash flow | $502 million | $925 million | Operating cash flow less capital expenditures; non-GAAP measure. |
| Cash, cash equivalents and marketable securities | $4.392 billion | $5.018 billion at Dec. 31, 2010 | Quarter-end liquidity declined $626 million. |
| Total debt / net debt | $5.619 billion / $1.227 billion | $5.452 billion / $434 million at Dec. 31, 2010 | Debt was 25% of total capital; net debt increased. |
| Working capital | $6.745 billion | $6.126 billion at Dec. 31, 2010 | Increase primarily reflected receivables and inventory. |
Operating margin pressure reflected higher raw-material costs, pension and postretirement expense, Japan-related disruption and the absence of H1N1-related sales. Management said volume leverage helped offset these pressures. Q1 currency effects, including hedging, were estimated to have increased 3M-attributable net income by approximately $47 million.
Segments and material changes
All six segments recorded sales growth. Industrial and Transportation led with sales up 20.3% to $2.450 billion; Electro and Communications rose 20.5% to $836 million. Health Care sales increased 12.7% to $1.255 billion, but its margin fell to 29.4% from 31.1%. Consumer and Office operating income declined 1.9% to $215 million and its margin fell to 21.5% from 24.0%, reflecting growth investment and material costs. Segment comparisons were recast for product transfers effective in Q1 2011.
3M completed four business combinations, including acquisition of a controlling interest in Winterthur Technologie AG; acquisition cash outflow, net of cash acquired, was $471 million. 3M owned approximately 94% of Winterthur at quarter-end. The company also repurchased $680 million of stock and paid $392 million in dividends. Its new authorization permits up to $7.0 billion of repurchases; approximately $6.6 billion remained available at March 31.
Outlook and management commentary
- For 2011, 3M expected sales growth of at least 12%, comprising organic volume growth of 6%–7.5%, currency contribution of 2%–3% (at March 31 exchange rates) and acquisitions of 4%–6%.
- Management estimated Japan-related disruption would reduce full-year sales growth by about 1 percentage point, operating margin by 0.30 percentage points and diluted EPS by approximately $0.10–$0.13. It expected further impact in Q2, easing in the second half.
- Expected 2011 effective tax rate was approximately 29.5%. Pension and postretirement expense was expected to reduce 2011 earnings by approximately $0.22 per diluted share versus 2010. The company expected $400–$600 million of pension and postretirement contributions and $1.3–$1.4 billion of capital spending.
- Management expected price increases to largely offset 2011 raw-material inflation. It cited strong liquidity, access to capital markets and an EBITDA-to-interest covenant ratio of approximately 36:1 versus a 3:1 minimum.
Risks, contingencies and unusual items
- Japan disruption: Affected automotive OEM and consumer-electronics businesses; 3M reported its Japan facilities were operational and no material disaster-related asset impairment had been recorded.
- Legal and environmental exposures: Recorded respirator-mask/asbestos liabilities were $123 million, with $121 million of related insurance receivables; environmental remediation liabilities were $30 million with $15 million of related receivables, plus $85 million of other environmental liabilities. The company said potential losses beyond some reserves could not be estimated clearly.
- PFC-related matters: Regulatory reviews and litigation continued, including a Minnesota state natural-resources lawsuit and Alabama claims. 3M had not recorded liabilities for certain environmental litigation it considered not probable and estimable.
- Other litigation and compliance: Matters included a Meda AB claim seeking at least $200 million, Cogent appraisal litigation, patent/antitrust disputes with Avery Dennison, and an ongoing internal investigation concerning alleged conduct at a Turkish subsidiary. 3M said outcomes could not be predicted.
- Investment liquidity: $7 million of auction-rate securities remained illiquid after failed auctions; access to the funds depends on a successful auction or another buyer.
- Key operating risks: Global economic conditions, foreign exchange, competition and pricing, raw-material and energy costs, supply interruptions, acquisitions, regulatory changes and litigation. Pension funding and tax outcomes may also affect cash flows.
Most important facts for investors to verify
- Whether sales growth converts into improved margins as Japan disruption, raw-material inflation and pension costs evolve.
- Whether operating cash flow recovers after the working-capital investment and other cash-flow pressures in Q1.
- Whether the 2011 sales, tax-rate, pension-contribution and capital-spending outlook remains achievable.
- How Winterthur and other acquisitions perform, and the effect of the $7 billion repurchase authorization on cash and debt.
- Whether legal, environmental and compliance developments change reserves, insurance recoveries or potential exposure.