3M Company — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with the three months ended March 31, 2015 unless otherwise noted. 3M is a diversified global manufacturer operating across Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer. Interim financial statements are unaudited.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Net sales | $7.409 billion | $7.578 billion | Down 2.2%; organic local-currency sales down 0.8%, with currency translation reducing sales 3.0% |
| Operating income | $1.788 billion | $1.730 billion | Up 3.3% |
| Operating margin | 24.1% | 22.8% | Up 1.3 percentage points |
| Net income attributable to 3M | $1.275 billion | $1.199 billion | Up 6.3% |
| Diluted EPS | $2.05 | $1.85 | Up 10.8% |
| Operating cash flow | $1.260 billion | $1.080 billion | Up $180 million |
| Free cash flow | $946 million | $789 million | Conversion was 74% versus 66% |
Cost of sales was 49.6% of sales versus 50.5%; SG&A was 20.2% versus 20.6%; R&D remained 6.1%. Management attributed margin improvement chiefly to higher selling prices, lower raw-material costs, lower pension and postretirement expense, and restructuring-related productivity. These gains were partly offset by lower organic volume, reduced asset utilization, currency impacts, strategic investment, and acquisition impacts.
At March 31, 2016, cash and cash equivalents were $1.337 billion and marketable securities totaled $191 million. Total debt was $11.139 billion and net debt was $9.611 billion, up from $8.872 billion at year-end 2015. Debt was 49% of total capital, versus 48% at year-end. Working capital was $3.696 billion, down $172 million from year-end. The $3.75 billion revolving credit facility was undrawn; the company reported an EBITDA-to-interest ratio of approximately 51:1 against a 3:1 minimum covenant.
Capital returned to shareholders included $1.227 billion of share repurchases and $672 million of dividends. The quarterly dividend was $1.11 per share, up 8% year over year. Q1 capital spending was $314 million.
Material changes and segment performance
- Sales declined overall despite growth in three segments. Health Care sales rose 4.0% and operating income rose 11.5%; Safety and Graphics sales rose 2.9%; Industrial sales fell 3.0%; Consumer sales were nearly flat.
- Electronics and Energy was the principal weakness: sales fell 13.6%, organic local-currency sales fell 11.7%, and operating income fell 26.8%. Management cited soft electronics demand, elevated channel inventory, and a difficult comparison.
- Foreign currency translation reduced worldwide sales by 3.0%; currency effects, including hedging, reduced pre-tax income by approximately $50 million.
- Q1 included a $40 million pre-tax gain from the sales of the remaining library systems assets and the Polyfoam business. The Polyfoam business had annual sales of approximately $20 million.
- 3M early adopted share-based payment accounting guidance effective January 1, 2016. It recognized an $81 million tax benefit in Q1; this materially contributed to the lower quarterly effective tax rate.
- Moody’s downgraded 3M from Aa3 to A1 in March and revised its outlook to stable; S&P’s AA- rating and Moody’s short-term P-1 rating were affirmed.
Outlook, management commentary, and risks
- Management reported mixed global economic growth and a stronger U.S. dollar. Organic local-currency sales grew in three of five segments and in major regions except Asia Pacific.
- 3M expected its full-year 2016 effective tax rate to be approximately 29.5%–30.5%, above Q1’s 26.8%, citing planned global cash-optimization actions and other factors. The filing does not provide clear full-year sales or EPS guidance.
- Management expected 2016 capital spending of approximately $1.3–$1.5 billion and gross share repurchases of $4–$6 billion. Expected global defined-benefit pension and postretirement expense was approximately $320 million lower in 2016 than in 2015; expected 2016 plan contributions were $200–$400 million.
- Prior-year restructuring actions affected approximately 1,700 positions and carried a $114 million pre-tax charge; management estimated approximately $130 million of 2016 savings. In late April 2016, 3M announced approximately 250 additional position reductions in Electronics and Energy and expected a roughly $20 million Q2 expense.
- Key risks include global economic and foreign-exchange conditions, competitive and customer-demand changes, raw-material availability and prices, acquisitions and restructuring execution, credit ratings and leverage, pension funding, cybersecurity and ERP implementation, and legal, regulatory, and environmental proceedings.
- Significant contingencies include respirator/asbestos litigation (approximately 2,110 claimants; $141 million accrued, excluding Aearo, and $39 million of related insurance receivables; Aearo accrued $21 million), environmental liabilities of $77 million with $26 million of related insurance receivables, and ongoing PFC-related proceedings. The company stated that it could not estimate potential losses above certain accruals. In March, 3M paid TransWeb $27 million after an appellate court affirmed the judgment.
- Other notable legal exposure includes an EDF claim in France concerning electrical splices; a court-appointed expert reported damages exceeding €100 million, but the report was not a determination of liability or damages. 3M also faced approximately 260 Bair Hugger-related lawsuits; no liability was recorded for that matter.
Investor verification priorities
- Assess the persistence of Q1’s margin and EPS improvement, including the $81 million share-based-payment tax benefit, $40 million divestiture gain, and lower pension costs.
- Track organic demand and inventory trends in Electronics and Energy, Industrial, and Asia Pacific, and distinguish underlying sales from currency, acquisition, and divestiture effects.
- Verify execution of the $4–$6 billion repurchase plan and the effect of intended higher leverage on debt, credit ratings, and funding costs.
- Monitor 2016 tax-rate progression against management’s 29.5%–30.5% estimate, as well as capital spending, pension contributions, and restructuring savings and costs.
- Review updates to asbestos, PFC/environmental, EDF, and Bair Hugger proceedings, including changes to accruals, insurance recoveries, and any newly estimable loss ranges.