3M Company — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with the three months ended March 31, 2016, unless noted. Amounts are in U.S. dollars. Interim financial statements are unaudited and were reviewed by the independent accountant.
Business context and results
3M is a diversified global manufacturer operating in Industrial, Safety and Graphics, Health Care, Electronics and Energy, and Consumer. The company changed its segment reporting in Q1 2017; comparative segment figures were recast under the new structure.
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $7.685 billion | $7.409 billion | +3.7%; organic local-currency sales +4.6% |
| Operating income | $1.774 billion | $1.788 billion | -0.8% |
| Operating margin | 23.1% | 24.1% | -1.0 percentage point |
| Net income attributable to 3M | $1.323 billion | $1.275 billion | +3.8% |
| Diluted EPS | $2.16 | $2.05 | +5.4% |
| Effective tax rate | 23.7% | 26.8% | -3.1 percentage points |
| Operating cash flow | $988 million | $1.260 billion | Down $272 million |
| Free cash flow (company-defined, non-GAAP) | $701 million | $946 million | Down $245 million |
Sales growth included 4.6% organic local-currency growth, offset in part by divestitures (-0.4%) and currency translation (-0.5%). Electronics and Energy led segment growth; Consumer sales declined slightly. Management attributed the lower operating margin mainly to incremental strategic investments, currency effects, higher pension and postretirement costs, and lower divestiture gains. Organic growth, productivity and lower raw-material costs provided offsets.
Segments
| Segment | Sales | Sales change | Operating income |
|---|---|---|---|
| Industrial | $2.709 billion | +4.2% | $625 million |
| Safety and Graphics | $1.527 billion | +3.4% | $399 million |
| Health Care | $1.423 billion | +2.3% | $434 million |
| Electronics and Energy | $1.210 billion | +11.1% | $225 million |
| Consumer | $1.042 billion | -0.7% | $222 million |
Electronics and Energy benefited from stronger electronics demand, particularly in Asia Pacific. Health Care operating income fell 5.2%, and Consumer operating income fell 6.8%. Segment results include the company’s dual-credit reporting convention; they are not presented as results of independently operated businesses.
Cash, debt and liquidity
- Cash and cash equivalents were $2.173 billion at March 31, 2017, versus $2.398 billion at year-end 2016. Cash, equivalents and marketable securities totaled $2.331 billion.
- Total debt was $11.711 billion, versus $11.650 billion at year-end; company-defined net debt rose to $9.380 billion from $8.955 billion. Debt was 51% of total capital, down from 53%.
- Current assets were $11.901 billion and current liabilities $5.995 billion. The $3.75 billion revolving credit facility was undrawn; the company reported an EBITDA-to-interest covenant ratio of approximately 45:1 against a 3:1 minimum.
- Q1 capital spending was $287 million. Cash dividends paid were $702 million, and the company repurchased $690 million of stock. Cash decreased by $225 million during the quarter.
- Operating cash flow declined mainly because of pension contribution timing, inventory growth, and higher cash income taxes. Free cash flow is a non-GAAP company-defined measure, and Q1 is typically its seasonal low.
Outlook, commentary and unusual items
- Management expected a 2017 effective tax rate of 26.0%–27.5%, capital spending of $1.3–$1.5 billion, and gross share repurchases of $2.5–$4.5 billion. It expected $300–$500 million of 2017 contributions to global defined benefit pension and postretirement plans.
- After quarter-end, 3M completed the identity management divestiture for $850 million, subject to adjustments, and expected a pretax gain of about $470 million, or approximately $0.55 per diluted share. For the rest of 2017, it expected related lost earnings of about $0.05 per share and portfolio and footprint costs of $0.40–$0.45 per share; management estimated a net full-year EPS benefit of $0.05–$0.10 from these items.
- 3M announced a proposed $2.0 billion acquisition of Scott Safety, expected to close in the second half of 2017 subject to customary conditions and approvals. The business reported 2016 revenue of about $570 million.
- Q1 included $136 million of year-on-year incremental strategic investments: $36 million for growth initiatives and $100 million for productivity and portfolio actions, including $80 million of asset charges and accelerated depreciation and $20 million of severance and other charges. 3M also recorded about $40 million of long-lived asset impairments in Electronics and Energy and a $29 million pretax gain on the safety prescription eyewear sale.
- Material disclosed contingencies include respirator mask/asbestos liabilities accrued at $583 million, plus $19 million of Aearo-related accruals; related insurance receivables for the principal respirator accrual were $4 million. The filing states the company cannot estimate potential losses above these accruals.
- 3M reported multiple PFC-related environmental and drinking-water proceedings. Environmental liabilities included $36 million for remediation and $29 million for other environmental matters, with an $8 million related insurance receivable for remediation. For certain matters, the company said additional losses could not be estimated.
- The Bair Hugger patient-warming litigation involved approximately 1,790 plaintiffs as of March 31, up from about 1,260 at year-end; no liability was recorded because 3M said a loss was not then probable and estimable. Other risks include foreign exchange, global economic conditions, competition, raw-material supply and cost, pension funding, legal and regulatory outcomes, and cybersecurity/ERP implementation.
3M estimated currency effects, including hedging, reduced Q1 pretax income by approximately $34 million in its EPS analysis; a separate disclosure estimated derivative and other transaction gains and losses reduced pretax income by approximately $37 million. The filing does not provide a general full-year EPS guidance figure in the presented text.
Most important facts for investors to verify
- Whether organic sales growth and segment trends persist, especially Electronics and Energy’s rebound and weakness in Consumer and Health Care profitability.
- How much of the margin decline reflects temporary strategic/portfolio spending versus ongoing cost or pricing pressure, and whether anticipated productivity gains materialize.
- Actual 2017 cash generation, working-capital needs, pension contributions, capital spending and share repurchases relative to management’s stated ranges.
- Final Scott Safety purchase price, closing conditions, financing and integration plans; and the realized gain and earnings impact of the identity management sale.
- Developments in respirator, PFC/environmental and Bair Hugger matters, including possible changes in accruals, insurance recovery or loss estimates.
- Whether leverage and credit ratings remain consistent with the company’s capital-return and acquisition plans.