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MMM > SEC Filings for MMM > Form 10-Q on 31-Jul-2014All Recent SEC Filings

Show all filings for 3M CO

Form 10-Q for 3M CO


31-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of 3M's financial statements with a narrative from the perspective of management. 3M's MD&A is presented in the following sections:

          Overview

          Results of Operations

          Performance by Business Segment

          Financial Condition and Liquidity

          Cautionary Note Concerning Factors That May Affect Future Results

OVERVIEW

3M is a diversified global manufacturer, technology innovator and marketer of a wide variety of products and services. 3M manages its operations in five operating business segments: Industrial; Safety and Graphics; Electronics and Energy; Health Care; and Consumer. From a geographic perspective, any references to EMEA refer to Europe, Middle East and Africa on a combined basis.

As described in 3M's Current Report on Form 8-K dated May 15, 2014 (which updated 3M's 2013 Annual Report on Form 10-K) and 3M's Quarterly Report on Form 10-Q for the period ended March 31, 2014, effective in the first quarter of 2014, 3M transferred a product line between divisions within different business segments and made other changes within business segments in its continuing effort to improve the alignment of its businesses around markets and customers. Segment information presented herein reflects the impact of these changes for all periods presented. This quarterly report on Form 10-Q should be read in conjunction with the Company's consolidated statements and notes included in its Current Report on Form 8-K dated May 15, 2014.

In addition, effective in the second quarter of 2014, within the Electronics and Energy business segment, 3M combined three existing divisions into two new divisions. A large portion of both the Electronics Markets Materials Division and the Electronic Solutions Division were combined to form the Electronics Materials Solutions Division, which focuses on semiconductor and electronics materials and assembly solutions. The Optical Systems Division, the remaining portion of the Electronic Solutions Division and a portion of the Electronics Markets Materials Division were combined to form the Display Materials and Systems Division, which focuses on delivering light, color and user interface solutions.

Net income attributable to 3M was $1.267 billion, or $1.91 per diluted share, in the second quarter of 2014, compared to $1.197 billion, or $1.71 per diluted share, in the second quarter of 2013. Second-quarter 2014 sales increased 4.9 percent to $8.1 billion. 3M achieved organic local-currency sales growth (which includes organic volume impacts plus selling price impacts) in all five of its business segments. Organic local-currency sales increased 6.4 percent in Electronics and Energy, 5.1 percent in Health Care, 4.7 percent in both the Industrial business segment and Safety and Graphics, and 4.2 percent in Consumer. For the Company in total, organic local-currency sales grew 4.8 percent, with higher organic volumes contributing 3.5 percent and selling price increases contributing 1.3 percent. Acquisitions added 0.1 percent to sales, which related to the April 2014 acquisition of Treo Solutions LLC (Health Care business segment). Foreign currency translation had no impact on worldwide sales. Foreign currency translation benefited EMEA sales by 3.7 percent, with this benefit completely offset in other geographic areas as foreign currency translation reduced Latin America/Canada sales by 5.8 percent and Asia Pacific sales by 0.7 percent.

On a geographic basis, second-quarter 2014 organic local-currency sales growth was positive across all geographic areas. Asia Pacific local-currency sales growth of 6.6 percent was broad-based, with all five business segments growing, led by Electronics and Energy, and Consumer. Based on sales, Electronics and Energy is the largest business segment in Asia Pacific, with results significantly impacted by electronics-related divisions (Display Materials and Systems Division, and the Electronics Materials Solutions Division). Organic local-currency sales growth was 7 percent in Japan, or 2 percent without electronics-related businesses. China/Hong Kong organic local-currency sales growth was 6 percent, or 10 percent without electronics-related businesses, which was an improvement versus the first quarter's underlying growth rate. Refer to the Electronic and Energy business segment section for additional discussion of electronics-related businesses.

In EMEA, organic local-currency sales increased 4.8 percent. Organic local-currency sales growth was led by Middle East/Africa and Central/East Europe. Organic local-currency sales growth in West Europe was 3.5 percent. Sales growth in EMEA was led by Safety and Graphics, Electronics and Energy, and Industrial.


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In the United States, organic local-currency sales growth was 4.5 percent, up from first quarter year-on-year sales growth of 2.6 percent, led by Health Care, and Safety and Graphics.

In Latin America/Canada, organic local-currency sales grew 2.7 percent, led by Electronics and Energy, and Health Care. Latin America/Canada organic sales growth was led by Mexico, and Brazil was down slightly. Sales and operating income were down substantially in Venezuela during the second quarter of 2014.

Operating income increased 9.1 percent in the second quarter and operating margins were 22.8 percent, a margin increase of 0.8 percentage points year-on-year. These results benefited from the combination of selling price increases and raw material cost decreases, lower pension and postretirement benefit costs, plus leverage from organic volume growth. These benefits were partially offset by the impact of strategic investments and foreign exchange impacts. Refer to the section entitled "Results of Operations" for further discussion.

The income tax rate was 29.5 percent in the second quarter, up 2.1 percentage points versus last year's second quarter. This higher rate decreased earnings per diluted share by approximately 5 cents. Weighted-average diluted shares outstanding in the second quarter of 2014 declined 4.9 percent year-on-year to 664.6 million, which increased earnings per diluted share by approximately 9 cents. Foreign exchange impacts decreased earnings per diluted share by approximately 4 cents.

In the first six months of 2014, net income attributable to 3M was $2.474 billion, or $3.70 per diluted share, compared to $2.326 billion, or $3.32 per diluted share, in the first six months of 2013. First-half 2014 sales increased 3.8 percent to $16.0 billion. 3M achieved organic local-currency sales growth (which includes organic volume impacts plus selling price impacts) in all five of its business segments. Organic local-currency sales increased 5.7 percent in Health Care, 5.3 percent in Electronics and Energy, 4.8 percent in Industrial, 4.7 percent in Safety and Graphics, and 3.4 percent in Consumer. For the Company in total, organic local-currency sales grew 4.8 percent, with higher organic volumes contributing 3.6 percent and selling price increases contributing 1.2 percent. Foreign currency translation reduced sales by 1.0 percent year-on-year, with Latin America/Canada sales reduced by 8.5 percent and Asia Pacific sales reduced by 2.2 percent, while EMEA sales benefited by 2.8 percent.

The following table contains sales and operating income results by business segment for the three months ended June 30, 2014 and 2013. In addition to the discussion below, refer to the section entitled "Performance by Business Segment" later in MD&A for a more detailed discussion of the sales and income results of the Company and its respective business segments (including Corporate and Unallocated). Refer to Note 13 for additional information on business segments, including Elimination of Dual Credit.

                                      Three months ended June 30,
                                     2014                    2013                % change
                               Net      Operating      Net      Operating     Net    Operating
(Dollars in millions)         Sales      Income       Sales      Income      Sales    Income
Business Segments
Industrial                   $ 2,815   $       617   $ 2,683   $       603     4.9 %       2.4 %
Safety and Graphics            1,494           353     1,434           328     4.1         7.4
Electronics and Energy         1,422           293     1,340           237     6.2        23.4
Health Care                    1,416           434     1,336           417     5.9         4.1
Consumer                       1,139           241     1,098           235     3.7         2.3
Corporate and Unallocated         (1 )         (49 )       1           (87 )
Elimination of Dual Credit      (151 )         (33 )    (140 )         (31 )
Total Company                $ 8,134   $     1,856   $ 7,752   $     1,702     4.9 %       9.1 %

Sales in the second quarter of 2014 increased 4.9 percent, led by Electronics and Energy at 6.2 percent, Health Care at 5.9 percent, Industrial at 4.9 percent, Safety and Graphics at 4.1 percent, and Consumer at 3.7 percent. Total company organic local-currency sales increased 4.8 percent, acquisitions increased sales by 0.1 percent, and foreign currency translation had no impact on worldwide sales. All five of 3M's business segments achieved operating income margins in excess of 20 percent. Worldwide operating income margins for the second quarter of 2014 were 22.8 percent, compared to 22.0 percent for the second quarter of 2013.


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3M generated $2.732 billion of operating cash flows in the first six months of 2014, an increase of $59 million when compared to the first six months of 2013. Refer to the section entitled "Financial Condition and Liquidity" later in MD&A for a discussion of items impacting cash flows.

In February 2014, 3M's Board of Directors authorized the repurchase of up to $12 billion of 3M's outstanding common stock, which replaced the Company's February 2013 repurchase program. This new program has no pre-established end date. In the first six months of 2014, the Company purchased $3.134 billion of stock, of which a portion was under the previous authorization, compared to $1.995 billion of stock purchases in the first six months of 2013. As of June 30, 2014, approximately $9.2 billion remained available under the February 2014 authorization. The Company expects to purchase $4.5 billion to $5.0 billion of stock in 2014. In December 2013, 3M's Board of Directors declared a first-quarter 2014 dividend of $0.855 per share, an increase of 35 percent. This marked the 56th consecutive year of dividend increases for 3M.

3M's debt to total capital ratio (total capital defined as debt plus equity) was 28 percent at June 30, 2014 and 25 percent at December 31, 2013. 3M has an AA- credit rating with a stable outlook from Standard & Poor's and an Aa2 credit rating with a stable outlook from Moody's Investors Service. The Company generates significant ongoing cash flow and has proven access to capital markets funding throughout business cycles.

3M expects to contribute approximately $100 million to $200 million of cash to its global pension and postretirement plans in 2014. The Company does not have a required minimum cash pension contribution obligation for its U.S. plans in 2014. 3M expects defined benefit pension and postretirement expense in 2014 to decrease by approximately $160 million pre-tax when compared to 2013. The change in both defined benefit and defined contribution plan expenses would increase earnings in 2014 by approximately 15 cents per diluted share when compared to 2013. Refer to Note 8 (Pension and Postretirement Benefit Plans) for additional information concerning 3M's pension and post-retirement plans. In addition, 3M currently expects that its effective tax rate for 2014 will be approximately 28.0 to 29.0 percent, compared to 28.1 percent for 2013. The 2014 estimate assumes that the U.S. research and development credit will be reinstated for 2014.

As discussed in Note 4, in July 2014, 3M announced that it will acquire (via Sumitomo 3M Limited) Sumitomo Electric Industries, Ltd.'s 25 percent interest in 3M's consolidated Sumitomo 3M Limited subsidiary for 90 billion Japanese Yen (approximately $885 million at announcement date exchange rates). This will add approximately $0.08 per diluted share to earnings during the first 12 months following closing, with closing expected on September 1, 2014. As a result of this transaction, 3M expects that its balance sheet amounts for noncontrolling interest equity and 3M Company shareholders' equity will be reduced by approximately $460 million and $425 million, respectively, based on June 30, 2014 balances, with an aggregate offsetting reduction to cash held by foreign subsidiaries.

Forward-looking statements in Part I, Item 2 may involve risks and uncertainties that could cause results to differ materially from those projected (refer to the section entitled "Cautionary Note Concerning Factors That May Affect Future Results" in Part I, Item 2 and the risk factors provided in Part II, Item 1A for discussion of these risks and uncertainties).


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RESULTS OF OPERATIONS

Percent change information compares the second quarter of 2014 with the same period last year, unless otherwise indicated.

Net Sales:



                                                  Three months ended June 30, 2014
                                                     Europe,        Latin
                          United        Asia       Middle East     America/         Other
                          States      Pacific       & Africa        Canada       Unallocated     Worldwide
Net sales (millions)     $   2,936   $    2,371   $       1,929   $      901    $          (3 ) $     8,134
% of worldwide sales          36.1 %       29.1 %          23.7 %       11.1 %              -         100.0 %
Components of net
sales change:
Volume - organic               3.6 %        6.4 %           3.6 %       (2.2 )%             -           3.5 %
Price                          0.9          0.2             1.2          4.9                -           1.3
Organic local-currency
sales                          4.5          6.6             4.8          2.7                -           4.8
Acquisitions                   0.2            -               -            -                -           0.1
Divestitures                  (0.1 )          -               -            -                -             -
Translation                      -         (0.7 )           3.7         (5.8 )              -             -
Total sales change             4.6 %        5.9 %           8.5 %       (3.1 )%             -           4.9 %

Sales in the second quarter of 2014 increased 4.9 percent when compared to the second quarter of 2013. Organic local-currency sales grew 4.8 percent, with increases of 6.6 percent in Asia Pacific, 4.8 percent in Europe, Middle East and Africa, 4.5 percent in the United States, and 2.7 percent in Latin America/Canada. Organic local-currency sales growth was 7 percent across all developing markets, and 4 percent in developed markets. Currency impacts had no impact on second quarter 2014 worldwide sales growth, with a benefit in EMEA offset by impacts in Latin America/Canada and Asia Pacific.

Worldwide selling prices rose 1.3 percent in the second quarter of 2014. Selling prices continue to be supported by technology innovation, which is a key fundamental strength of the Company, helping to drive unique customer solutions and an increasing flow of new products. 3M also began raising selling prices in mid-2013 to help offset currency weakness in select developing countries. This will result in 3M's price performance moderating in the second half of 2014, beginning in the third quarter.

                                                   Six months ended June 30, 2014
                                                     Europe,        Latin
                          United        Asia       Middle East     America/         Other
                          States      Pacific       & Africa        Canada       Unallocated     Worldwide
Net sales (millions)     $   5,707   $    4,732   $       3,791   $    1,741    $          (6 ) $    15,965
% of worldwide sales          35.7 %       29.6 %          23.8 %       10.9 %              -         100.0 %
Components of net
sales change:
Volume - organic               2.8 %        6.4 %           3.2 %       (1.0 )%             -           3.6 %
Price                          0.7          0.4             1.0          5.6                -           1.2
Organic local-currency
sales                          3.5          6.8             4.2          4.6                -           4.8
Acquisitions                   0.1            -               -            -                -             -
Divestitures                  (0.1 )          -               -            -                -             -
Translation                      -         (2.2 )           2.8         (8.5 )              -          (1.0 )
Total sales change             3.5 %        4.6 %           7.0 %       (3.9 )%             -           3.8 %

Sales in the first six months of 2014 increased 3.8 percent when compared to the first six months of 2013. Organic local-currency sales grew 4.8 percent, with increases of 6.8 percent in Asia Pacific, 4.6 percent in Latin America/Canada, 4.2 percent in Europe, Middle East and Africa, and 3.5 percent in the United States. Organic local-currency sales growth was 6 percent across all developing markets, and 4 percent in developed markets. Currency impacts reduced first six months 2014 worldwide sales growth by 1.0 percent.

Worldwide selling prices rose 1.2 percent in the first six months of 2014, as 3M continues to experience positive selling price changes across most of its businesses. As discussed in second-quarter results above, 3M also began raising selling prices in mid-2013 to help offset currency weakness in select developing countries.


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Operating Expenses:



                               Three months ended                Six months ended
                                    June 30,                         June 30,
(Percent of net sales)     2014       2013      Change      2014       2013      Change
Cost of sales                51.5 %     51.7 %     (0.2 )%    51.5 %     51.8 %     (0.3 )%
Selling, general and
administrative
expenses                     20.2       20.8       (0.6 )     20.5       20.8       (0.3 )
Research, development
and related expenses          5.5        5.5          -        5.6        5.6          -
Operating income             22.8 %     22.0 %      0.8 %     22.4 %     21.8 %      0.6 %

As discussed in the overview section, 3M expects defined benefit pension and postretirement expense for total year 2014 to decrease by approximately $160 million pre-tax when compared to 2013, which impacts cost of sales; selling, general and administrative expenses (SG&A); and research, development and related expenses (R&D). Refer to the 3M's Current Report on Form 8-K dated May 15, 2014 (MD&A section entitled Critical Accounting Estimates - Pension and Postretirement Obligations) for background concerning this reduction. The year-on-year decrease in defined benefit pension and postretirement expense for the second quarter and first six months was $39 million and $79 million, respectively.

Cost of Sales:

Cost of sales includes manufacturing, engineering and freight costs. Cost of sales as a percent of net sales was 51.5 percent in both the second quarter and first six months of 2014, down 0.2 and 0.3 percentage points, respectively, from the same periods last year. Cost of sales as a percent of sales decreased due to the combination of selling price increases and raw material cost decreases, as selling prices rose 1.3 percent and 1.2 percent in the second quarter and first six months, respectively. Raw material cost deflation was approximately 2 percent favorable year-on-year for both the second quarter and first six months. In addition, lower pension and postretirement costs (of which a portion impacts cost of sales), along with organic volume leverage, decreased cost of sales as a percent of sales. These benefits were partially offset by foreign exchange impacts.

Selling, General and Administrative Expenses:

SG&A increased 2.2 percent and 2.5 percent in the second quarter and first six months of 2014, respectively, when compared to the same periods last year. Second quarter and first six months 2014 SG&A included strategic investments in business transformation and 3M's global enterprise resource planning (ERP) implementation, which were partially offset by lower pension and postretirement expense. SG&A, measured as a percent of sales, was 20.2 percent of sales in the second quarter of 2014 and 20.5 percent of sales in the first six months of 2014, compared to 20.8 percent in the same periods last year.

Research, Development and Related Expenses:

R&D expense increased approximately 5 percent in both the second quarter and first six months of 2014 when compared to the same periods last year. 3M continued to invest in its key growth initiatives, including more R&D aimed at disruptive innovation, which refers to innovation that helps create a new market and which eventually disrupts an existing market. These increases were partially offset by lower pension and postretirement expense. R&D, measured as a percent of sales, was 5.6 percent of sales in both the first six months of 2014 and 2013.

Operating Income:

Operating income margins were 22.8 percent in the second quarter of 2014 compared to 22.0 in the second quarter of 2013, an increase of 0.8 percentage points. These results included a 1.2 percentage point benefit from the combination of higher selling prices and lower raw material costs. In addition, lower year-on-year pension and postretirement benefit costs provided a 0.5 percentage point benefit and profit leverage on organic volume growth added 0.3 percentage points. Items that reduced operating income margins included a 0.4 percentage point impact from strategic investments. Strategic investments included incremental increases in new disruptive R&D programs, business transformation and ERP costs, and the establishment of a new manufacturing, supply chain, and distribution Center of Expertise in Europe, all of which


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are expected to strengthen 3M for the future. Foreign exchange impacts reduced operating income margins by 0.6 percentage points and other items reduced margins by 0.2 percentage points.

Operating income margins were 22.4 percent in the first six months of 2014 compared to 21.8 in the first six months of 2013, an increase of 0.6 percentage points. These results included a 1.2 percentage point benefit from the combination of higher selling prices and lower raw material costs. In addition, lower year-on-year pension and postretirement benefit costs provided a 0.5 percentage point benefit and profit leverage on organic volume growth added 0.3 percentage points. Items that reduced operating income margins included a 0.6 percentage point impact from strategic investments, which included disruptive R&D, business transformation and ERP costs, the Center of Expertise in Europe, and restructuring. Foreign exchange impacts reduced operating income margins by 0.5 percentage points, and other items reduced margins by 0.3 percentage points.

Interest Expense and Income:



                      Three months ended         Six months ended
                           June 30,                  June 30,
(Millions)            2014           2013        2014         2013
Interest expense   $       45     $       41   $      82     $   80
Interest income            (9 )          (10 )       (18 )      (20 )
Total              $       36     $       31   $      64     $   60

Interest expense was higher in the second quarter and first six months of 2014 compared to the same periods last year, primarily due to international bank borrowings and a higher debt balance for the Company, partially offset by the lower average financing costs from commercial paper and lower rates on new debt issuances. Interest income in the second quarter and first six months of 2014 is comparable to prior periods.

Provision for Income Taxes:

Three months ended Six months ended
June 30, June 30,
(Percent of pre-tax income) 2014 2013 2014 2013 Effective tax rate 29.5 % 27.4 % 28.5 % 28.2 %

The effective tax rate for the second quarter of 2014 was 29.5 percent, compared to 27.4 percent in the second quarter of 2013, an increase of 2.1 percentage points. Factors that increased the Company's effective tax rate on a combined basis by 2.1 percentage points year-on-year included the 2013 restoration of tax basis on certain assets for which depreciation was previously limited, international taxes as a result of changes to the geographic mix of income before taxes, lapse of the U.S. research and development credit as of January 1, 2014, adjustments to the Company's income tax reserves, and other items.

The effective tax rate for the first six months of 2014 was 28.5 percent, compared to 28.2 percent in the first six months of 2013, an increase of 0.3 percentage points. Factors which increased the Company's effective tax rate by 1.1 percentage points for the first six months of 2014 when compared to the same period for 2013 included the lapse of the U.S. research and development credit as of January 1, 2014, and international taxes as a result of changes to the geographic mix of income before taxes. This increase was partially offset by a 0.8 percentage point decrease as the result of adjustments to the Company's reserves and the restoration of tax basis on certain assets for which depreciation was previously limited. Refer to Note 5 for further discussion of income taxes.

During 2014, the Company will be establishing a new manufacturing, supply chain, and distribution center of expertise in Europe. As a result of this establishment, the Company may incur jurisdictional tax charges related to the transfer of certain functions to the center of expertise.

The Company currently expects that its effective tax rate for total year 2014 will be approximately 28.0 to 29.0 percent, which assumes that the U.S. research and development credit will be reinstated for 2014. The rate can vary from quarter to quarter due to discrete items, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors, such as geographic mix of income before taxes.


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Net Income Attributable to Noncontrolling Interest:



                                           Three months ended                  Six months ended
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