3M Company — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 7, 2019. 3M is a diversified global technology and manufacturing company with five segments: Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer. Segment reporting was reorganized in 2018; prior-period segment figures were recast for comparability.
Financial performance
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $32.765 billion | $31.657 billion |
| Operating income / margin | $7.207 billion / 22.0% | $7.692 billion / 24.3% |
| Net income attributable to 3M | $5.349 billion | $4.858 billion |
| Diluted EPS | $8.89 | $7.93 |
| Operating cash flow | $6.439 billion | $6.240 billion |
| Capital expenditures | $1.577 billion | $1.373 billion |
| Free cash flow (non-GAAP) | $4.862 billion | $4.867 billion |
| Total debt | $14.622 billion | $13.949 billion |
| Cash, cash equivalents and marketable securities | $3.270 billion | $4.156 billion |
| Net debt (non-GAAP) | $11.352 billion | $9.793 billion |
Sales rose 3.5%; organic local-currency sales increased 3.2% (volume +2.1%, price +1.1%). Acquisitions added 1.4 percentage points, divestitures reduced sales 1.3 points, and currency translation added 0.2 points. GAAP operating margin fell 2.3 percentage points, chiefly due to the Minnesota natural-resource-damages (NRD) charge. Excluding the NRD matter and TCJA measurement-period adjustments, 3M reported non-GAAP operating income of $8.104 billion, a 24.7% margin, net income of $6.295 billion and diluted EPS of $10.46. These adjusted measures are not GAAP.
The effective tax rate was 23.4%, versus 35.5% in 2017; 2017 included a $762 million net tax expense from enactment of the Tax Cuts and Jobs Act (TCJA). 2018 included $176 million of TCJA measurement-period tax expense, as well as NRD-related tax items.
Fourth-quarter results and segments
Q4 sales were $7.945 billion, down 0.6% from $7.990 billion; organic local-currency sales increased 3.0%, offset by divestitures and currency. GAAP diluted EPS was $2.27 versus $0.85, with the comparison distorted by the 2017 TCJA charge. Adjusted Q4 diluted EPS was $2.31 versus $2.10, up 10.0%; adjusted operating margin was 22.4% in both periods.
- Industrial: FY sales $12.267 billion, up 3.4%; operating income $2.737 billion, up 9.9%.
- Safety and Graphics: FY sales $6.827 billion, up 9.5%, including acquisition growth; operating income fell 16.7% to $1.720 billion, partly reflecting prior-year divestiture gains and Scott Safety acquisition impacts.
- Health Care: FY sales $6.021 billion, up 2.9%; operating income $1.799 billion, up 2.0%.
- Electronics and Energy: FY sales $5.472 billion, down 0.5%, including the Communication Markets divestiture; operating income rose 49.3% to $2.055 billion, boosted by the sale gain.
- Consumer: FY sales $4.796 billion, up 1.4%; operating income $1.027 billion, up 2.4%.
Liquidity, capital allocation and outlook
Current assets were $13.709 billion and current liabilities $7.244 billion at year-end. The $3.75 billion revolving credit facility was undrawn; commercial paper outstanding was $435 million. 3M reported investment-grade ratings of AA- (S&P) and A1 (Moody’s), both stable, and a covenant EBITDA-to-interest ratio of approximately 25:1 against a 3:1 minimum.
3M repurchased $4.9 billion of shares and paid $3.193 billion in dividends in 2018. It expected 2019 gross repurchases of $2.0–$4.0 billion and capital spending of $1.7–$1.9 billion. The board declared a first-quarter 2019 dividend of $1.44 per share, up 6%. Management estimated a 2019 effective tax rate of approximately 20–22%, pension and postretirement contributions of $100–$200 million, and pension expense about $130 million lower pre-tax than in 2018. In February 2019, 3M completed its M*Modal technology-business acquisition for about $0.7 billion cash and assumed approximately $0.3 billion of debt.
Material changes, unusual items and risks
- 3M agreed to provide Minnesota an $850 million grant to resolve the NRD lawsuit and recorded a $897 million pre-tax charge in Q1 2018. This was the largest identified unusual item affecting reported annual earnings.
- 3M sold substantially all of its Communication Markets Division in 2018, recording a $494 million pre-tax gain, and sold the remaining German services business for a further $15 million gain. Related restructuring actions affected approximately 1,200 positions and generated charges.
- Raw-material inflation was a headwind; management said productivity, reformulation and sourcing actions partly offset it. Currency effects reduced 2018 pre-tax income by an estimated $42 million.
- Key risks include global economic and trade conditions, competition and customer demand, foreign exchange, raw-material availability and cost, execution of productivity and worldwide ERP initiatives, cybersecurity, pension-market exposure, and legal, regulatory and environmental proceedings.
- PFAS-related litigation and regulation remain significant uncertainties. At year-end, 3M recorded $25 million for environmental remediation and $59 million for other environmental liabilities, with $8 million of related insurance receivables. The filing says losses on numerous PFAS matters were not considered probable and estimable and could not be reasonably quantified.
- Respirator-mask/asbestos accruals were $673 million, excluding Aearo’s $28 million accrual; 3M said potential amounts above these accruals could not be estimated. Bair Hugger patient-warming litigation involved approximately 5,015 plaintiffs; no liability was recorded because 3M considered any loss not probable and estimable. Additional military earplug lawsuits were filed in 2019.
- Worldwide pension plans were reported 89% funded. The primary U.S. qualified plan was 96% funded; its 2018 asset return was -0.5%. Funding needs and expense remain sensitive to market returns and discount rates.
Important facts for investors to verify
- Reconcile reported GAAP earnings with the company’s non-GAAP adjustments, particularly the NRD and TCJA items and Communication Markets sale gains.
- Review the scale, accrual assumptions, insurance recoveries and possible additional exposure from PFAS, respirator/asbestos, Bair Hugger and other litigation.
- Assess whether organic growth, pricing and productivity can offset raw-material inflation, currency impacts and segment-specific weakness.
- Monitor leverage and cash deployment, including debt maturities, planned repurchases, dividends and capital spending.
- Track pension funding and the costs, controls and operational risks associated with the ongoing ERP rollout.