3M Company — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless noted. 3M is a diversified global manufacturer organized into Industrial, Safety and Graphics, Electronics and Energy, Health Care, and Consumer segments. Interim financial statements are unaudited; the independent accountant conducted a review, not an audit.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Net sales | $7.831 billion | $7.634 billion; up 2.6% |
| Organic local-currency sales growth | 4.6% (volume 3.4%; price 1.2%) | Foreign exchange reduced sales growth by 2.0 percentage points |
| Operating income / margin | $1.716 billion / 21.9% | $1.646 billion / 21.6% |
| Net income attributable to 3M | $1.207 billion | $1.129 billion |
| Diluted EPS | $1.79 | $1.61 |
| Effective tax rate | 27.4% | 29.1% |
| Operating cash flow | $1.092 billion | $994 million |
| Free cash flow (company-defined, non-GAAP) | $799 million | $670 million |
| Cash and cash equivalents | $1.954 billion | $2.581 billion at Dec. 31, 2013 |
| Total debt / net debt | $6.577 billion / $2.403 billion | $6.009 billion / $1.219 billion at Dec. 31, 2013 |
| Working capital | $5.312 billion | $5.235 billion at Dec. 31, 2013 |
Cost of sales fell to 51.5% of revenue from 52.0%, supporting margin improvement. Management attributed margin gains to pricing, lower raw-material costs, lower pension costs and volume leverage; strategic investments and foreign exchange partly offset these benefits. The company repurchased $1.708 billion of stock and paid $566 million in dividends. The quarterly dividend was $0.855 per share, up 34.6% year over year.
Material changes and segment results
- Sales increased in four segments: Health Care +4.8%, Industrial +3.1%, Electronics and Energy +2.7%, and Safety and Graphics +1.7%. Consumer sales declined 0.2%.
- Operating income rose in Industrial (+6.7%), Electronics and Energy (+16.1%), and Health Care (+5.6%); it declined in Safety and Graphics (-4.2%) and Consumer (-3.5%). Health Care had the highest segment operating margin at 31.1%.
- Foreign currency translation reduced total sales growth by 2.0 percentage points. Management estimated currency effects, including hedging, reduced 3M-attributable net income by about $29 million.
- Weighted-average diluted shares fell 3.9%; management estimated the lower share count added about $0.07 to diluted EPS. The lower tax rate added about $0.04 per diluted share.
- Segment reporting was realigned in Q1 2014, including transfer of the Fire Protection product line from Safety and Graphics to Industrial. Comparative segment figures were recast for the change.
- Operating cash flow improved by $98 million, although working-capital investment in receivables, inventory and payables used $394 million in Q1 2014.
Outlook, commentary and notable items
- Management expected 2014 capital spending of $1.7–$1.8 billion; pension and postretirement contributions of $100–$200 million; and an effective tax rate of approximately 28%–29%.
- Management expected $4–$5 billion of gross share repurchases in 2014 and planned $2–$4 billion of additional leverage versus year-end 2013. A new repurchase authorization permits up to $12 billion, with approximately $10.6 billion remaining at March 31.
- Management forecast 2014 defined-benefit pension and postretirement expense to decline about $160 million pretax versus 2013. It continued investment in R&D, ERP deployment, business transformation, restructuring and European manufacturing, supply-chain and distribution capabilities.
- Management cited severe winter weather as a drag on some U.S. channels, notably road construction, retail and industrial distribution. Japan’s pre-consumption-tax demand was elevated. Venezuela sales and operating income were substantially lower; 3M was managing exposure to currency restrictions and exchange-rate changes.
- In April 2014, after quarter-end, 3M completed its acquisition of Treo Solutions, a healthcare data analytics and business-intelligence provider.
- Also after quarter-end, a court ruled against 3M in the TransWeb patent/antitrust matter and stated it would enter a $26 million judgment. 3M intended to appeal. The filing notes other significant litigation, including respirator/asbestos claims and PFC-related environmental matters; outcomes and potential additional losses may be uncertain.
Risks and contingencies
- Respirator mask/asbestos liabilities were recorded at $148 million gross, with $53 million of related insurance receivables; the company increased its Q1 accrual by $7 million. Aearo-related accruals and allocation/indemnity arrangements carry additional uncertainty.
- Recorded environmental remediation and other environmental liabilities were $30 million and $46 million, respectively, with related insurance receivables of $11 million and $15 million. PFC remediation and regulatory developments may affect future costs.
- The Minnesota natural-resources PFC lawsuit and potential federal claims concerning the Passaic River remain relevant exposures. The company says it cannot estimate possible losses for several matters; its potential Passaic River share, if any, was described as likely a fraction of one percent of total proposed remedy costs.
- Other key risks include global economic conditions, foreign exchange, competition and product acceptance, input costs and supply continuity, acquisitions, productivity, cybersecurity and ERP implementation, legal/regulatory outcomes, and maintaining investment-grade credit ratings.
- 3M reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The worldwide ERP rollout continues and will require ongoing control testing.
Investor verification priorities
- Track whether organic sales growth and margin gains persist after currency effects, Japan’s demand timing, and lower raw-material costs.
- Verify execution of repurchase, leverage, capital-spending and pension-contribution plans against cash generation and credit ratings.
- Monitor the TransWeb appeal and the evolution of respirator/asbestos, PFC/environmental and other legal exposures, including insurance recoveries.
- Review working-capital trends, especially receivables and inventory, and the effect of upcoming Eurobond maturity and commercial-paper funding on liquidity.
- Assess segment comparability under the 2014 realignment and the financial impact of strategic investments and ERP deployment.