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3M CO - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) 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 $1.303 billion, or $1.98 per diluted share, in the third quarter of 2014, compared to $1.230 billion, or $1.78 per diluted share, in the third quarter of 2013. Third-quarter 2014 sales increased 2.8 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 5.4 percent in Health Care, 4.3 percent in Electronics and Energy, 4.2 percent in Industrial, and 3.1 percent in both the Consumer business segment and Safety and Graphics business segment. For the Company in total, organic local-currency sales grew 3.9 percent, with higher organic volumes contributing 3.2 percent and selling price increases contributing 0.7 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 reduced worldwide sales by 1.2 percent year-on-year, with Latin American/Canada sales reduced by 4.3 percent, Europe sales reduced by 2.1 percent, and Asia Pacific sales reduced by 0.8 percent. On a geographic basis, third-quarter 2014 organic local-currency sales growth was positive across all major geographic areas for the sixth consecutive quarter. The United States led with organic local-currency sales growth of 6.0 percent, including Industrial at 8 percent, Safety and Graphics at 7 percent, and Health Care at 6 percent. Asia Pacific local-currency sales growth was 4.9 percent, led by Health Care at 9 percent, and Electronics and Energy at 7 percent. 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 3 percent without electronics-related businesses. China/Hong Kong organic local-currency sales growth was 4 percent, or 3 percent without electronics-related businesses, impacted by a challenging sales growth comparison due to last year's strong third quarter growth. Refer to the Electronic and Energy business segment section for additional discussion of electronics-related businesses. 53 -------------------------------------------------------------------------------- Table of Contents In EMEA, organic local-currency sales increased 0.8 percent. Organic local-currency sales growth was led by Middle East/Africa and Central/East Europe, and declined slightly in West Europe. Organic local-currency sales growth in EMEA was positive in Health Care, Safety and Graphics, and Industrial, but declined in both Electronics and Energy, and Consumer. In Latin America/Canada, organic local-currency sales grew 0.4 percent, led by Health Care. Organic sales growth was more than 10 percent in Mexico, and Brazil grew approximately 4 percent. 3M continues to manage the currency risks related to Venezuela. Sales were down in the third quarter of 2014 in Venezuela, which reduced organic local-currency sales growth across Latin American/Canada by 6 percentage points. Since Venezuela is considered highly inflationary, 3M's Venezuelan subsidiary's functional currency is considered to be that of its parent. As a result, exchange rate effects of remeasuring Venezuelan Bolivar-denominated sales were reflected in organic local-currency growth as opposed to being part of the translation element of overall sales change. Operating income increased 9.4 percent in the third quarter and operating margins were 23.4 percent, a margin increase of 1.4 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, leverage from organic volume growth, plus productivity and other items. These benefits were partially offset by the impact of strategic investments. Refer to the section entitled "Results of Operations" for further discussion. The income tax rate was 30.3 percent in the third quarter, up 2.9 percentage points versus last year's third quarter. This higher rate decreased earnings per diluted share by approximately 8 cents. Weighted-average diluted shares outstanding in the third quarter of 2014 declined 4.9 percent year-on-year to 657.9 million, which increased earnings per diluted share by approximately 10 cents. Foreign exchange impacts decreased earnings per diluted share by approximately 2 cents. In the first nine months of 2014, net income attributable to 3M was $3.777 billion, or $5.67 per diluted share, compared to $3.556 billion, or $5.10 per diluted share, in the first nine months of 2013. First nine months 2014 sales increased 3.4 percent to $24.1 billion. 3M achieved organic local-currency sales growth in all five of its business segments. Organic local-currency sales increased 5.6 percent in Health Care, 4.9 percent in Electronics and Energy, 4.6 percent in Industrial, 4.1 percent in Safety and Graphics, and 3.3 percent in Consumer. For the Company in total, organic local-currency sales grew 4.5 percent, with higher organic volumes contributing 3.5 percent and selling price increases contributing 1.0 percent. Foreign currency translation reduced worldwide sales by 1.1 percent year-on-year. Foreign currency translation reduced Latin America/Canada sales by 7.1 percent and Asia Pacific sales by 1.7 percent, while EMEA sales benefited by 1.2 percent. The following table contains sales and operating income results by business segment for the three months ended September 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 September 30, 2014 2013 % change Net Operating Net Operating Net Operating (Dollars in millions) Sales Income Sales Income Sales Income Business Segments Industrial $2,772 $616 $2,692 $571 3.0 % 7.9 % Safety and Graphics 1,448 340 1,429 313 1.3 8.8 Electronics and Energy 1,500 338 1,449 300 3.5 12.5 Health Care 1,390 432 1,328 426 4.7 1.4 Consumer 1,177 272 1,153 247 2.1 10.1 Corporate and Unallocated 3 (63 ) 3 (88 ) Elimination of Dual Credit (153 ) (34 ) (138 ) (30 ) Total Company $8,137 $1,901 $7,916 $1,739 2.8 % 9.4 % Sales in the third quarter of 2014 increased 2.8 percent, with sales growth in Health Care at 4.7 percent, Electronics and Energy at 3.5 percent, Industrial at 3.0 percent, Consumer at 2.1 percent, and Safety and Graphics at 1.3 percent. Total company organic local-currency sales increased 3.9 percent, acquisitions increased sales by 0.1 percent, and foreign currency translation reduced sales by 1.2 percent. All five of 3M's business segments achieved operating income margins 54 -------------------------------------------------------------------------------- Table of Contents in excess of 22 percent. Worldwide operating income margins for the third quarter of 2014 were 23.4 percent, compared to 22.0 percent for the third quarter of 2013. 3M generated $4.443 billion of operating cash flows in the first nine months of 2014, an increase of $619 million when compared to the first nine 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 nine months of 2014, the Company purchased $4.373 billion of stock, of which a portion was under the previous authorization, compared to $3.538 billion of stock purchases in the first nine months of 2013. As of September 30, 2014, approximately $7.9 billion remained available under the February 2014 authorization. The Company expects to purchase $5.5 billion to $6.0 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 31 percent at September 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 negative outlook from Moody's Investors Service. In August 2014, Moody's Investor Service reaffirmed 3M's Aa2 credit rating, but changed 3M's outlook from stable to negative. 3M's ongoing transition to a more optimized capital structure, financed with additional low-cost debt, could impact 3M's credit rating in the future. The Company generates significant ongoing cash flow and has proven access to capital markets funding throughout business cycles. 3M expects to contribute approximately $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 28.5 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, on September 1, 2014, 3M purchased (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 $865 million at closing date exchange rates). Since this subsidiary was already being fully consolidated in 3M results, this transaction had no impact on operating income margins. However, since 3M now owns 100 percent of Sumitomo 3M Limited, the elimination of net income attributable to noncontrolling interest in this subsidiary (25 percent) is no longer required. This will add approximately $0.08 per diluted share to earnings during the first twelve months following closing (September 2014 through August 2015), of which approximately a $0.01 per diluted share benefit was realized in the third quarter of 2014. In addition, as a result of this transaction, the balance sheet amount for noncontrolling interest equity was reduced by approximately $460 million when compared to the June 30, 2014 balance. 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). 55 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Percent change information compares the third quarter of 2014 with the same period last year, unless otherwise indicated. Net Sales: Three months ended September 30, 2014 Europe, Latin United Asia Middle East America/ Other States Pacific & Africa Canada Unallocated Worldwide Net sales (millions) $ 3,075 $ 2,438 $ 1,725 $ 900 $ (1 ) $ 8,137 % of worldwide sales 37.8 % 30.0 % 21.2 % 11.0 % - 100.0 % Components of net sales change: Volume - organic 5.8 % 4.9 % (0.2 )% (2.8 )% - 3.2 % Price 0.2 - 1.0 3.2 - 0.7 Organic local-currency sales 6.0 4.9 0.8 0.4 - 3.9 Acquisitions 0.2 - - - - 0.1 Translation - (0.8 ) (2.1 ) (4.3 ) - (1.2 ) Total sales change 6.2 % 4.1 % (1.3 )% (3.9 )% - 2.8 % Sales in the third quarter of 2014 increased 2.8 percent when compared to the third quarter of 2013. Organic local-currency sales grew 3.9 percent, with increases of 6.0 percent in the United States, 4.9 percent in Asia Pacific, 0.8 percent in Europe, Middle East and Africa (EMEA), and 0.4 percent in Latin America/Canada. Organic local-currency sales growth was 3.7 percent across all developing markets, and 4.0 percent in developed markets. Currency impacts reduced third quarter 2014 worldwide sales by 1.2 percent, with Latin American/Canada sales reduced by 4.3 percent, EMEA sales reduced by 2.1 percent, and Asia Pacific sales reduced by 0.8 percent. Worldwide selling prices rose 0.7 percent in the third 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, as reflected in third quarter results. Nine months ended September 30, 2014 Europe, Latin United Asia Middle East America/ Other States Pacific & Africa Canada Unallocated Worldwide Net sales (millions) $ 8,782 $ 7,170 $ 5,516 $ 2,641 $ (7 ) $ 24,102 % of worldwide sales 36.4 % 29.7 % 22.9 % 11.0 % - 100.0 % Components of net sales change: Volume - organic 3.9 % 5.9 % 2.1 % (1.6 )% - 3.5 % Price 0.5 0.2 1.0 4.8 - 1.0 Organic local-currency sales 4.4 6.1 3.1 3.2 - 4.5 Acquisitions 0.1 - - - - - Divestitures (0.1 ) - - - - - Translation - (1.7 ) 1.2 (7.1 ) - (1.1 ) Total sales change 4.4 % 4.4 % 4.3 % (3.9 )% - 3.4 % Sales in the first nine months of 2014 increased 3.4 percent when compared to the first nine months of 2013. Organic local-currency sales grew 4.5 percent, with increases of 6.1 percent in Asia Pacific, 4.4 percent in the United States, 3.2 percent in Latin America/Canada, and 3.1 percent in EMEA. Organic local-currency sales growth was 5.0 percent across all developing markets, and 4.1 percent in developed markets. Currency impacts reduced first nine months 2014 worldwide sales growth by 1.1 percent. Worldwide selling prices rose 1.0 percent in the first nine months of 2014, as 3M continues to experience positive selling price changes across most of its businesses. As discussed in third-quarter results above, 3M also began raising selling prices in mid-2013 to help offset currency weakness in select developing countries. 56 -------------------------------------------------------------------------------- Table of Contents Operating Expenses: Three months ended Nine months ended September 30, September 30, (Percent of net sales) 2014 2013 Change 2014 2013 Change Cost of sales 51.7 % 52.4 % (0.7 )% 51.6 % 52.1 % (0.5 )% Selling, general and administrative expenses 19.6 20.3 (0.7 ) 20.2 20.6 (0.4 ) Research, development and related expenses 5.3 5.3 - 5.5 5.5 - Operating income 23.4 % 22.0 % 1.4 % 22.7 % 21.8 % 0.9 % 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 third quarter and first nine months was $42 million and $121 million, respectively. Cost of Sales: Cost of sales includes manufacturing, engineering and freight costs. Cost of sales as a percent of net sales was 51.7 percent in the third quarter and 51.6 percent for the first nine months of 2014, down 0.7 and 0.5 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 0.7 percent and 1.0 percent in the third quarter and first nine months, respectively. Raw material cost deflation was approximately 1.5 percent favorable year-on-year for both the third quarter and first nine 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. Selling, General and Administrative Expenses: SG&A in dollars decreased 0.7 percent and increased 1.4 percent in the third quarter and first nine months of 2014, respectively, when compared to the same periods last year. Third quarter and first nine months 2014 SG&A included strategic investments in business transformation and 3M's global enterprise resource planning (ERP) implementation, while lower pension and postretirement expense benefitted SG&A. SG&A, measured as a percent of sales, was 19.6 percent of sales in the third quarter of 2014 and 20.2 percent of sales in the first nine months of 2014, compared to 20.3 percent and 20.6 percent in the same periods last year, respectively. Research, Development and Related Expenses: R&D in dollars increased 3.3 percent in the third quarter and 4.5 percent in the first nine 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 5.5 percent of sales in both the first nine months of 2014 and 2013. Operating Income: Operating income margins were 23.4 percent in the third quarter of 2014 compared to 22.0 in the third quarter of 2013, an increase of 1.4 percentage points. These results included a 0.8 percentage point benefit from the combination of higher selling prices and lower raw material costs. Underlying selling prices remained firm across many of 3M's businesses, supported by technology innovation and strong new product flow. 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 0.2 percentage points. Productivity and other items provided a 0.5 percentage point benefit. 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, the establishment of a new manufacturing, supply chain and distribution center of expertise in Europe, plus selective restructuring, all of which are expected to strengthen 3M for the future. Foreign exchange impacts reduced operating income margins by 0.1 57 -------------------------------------------------------------------------------- Table of Contents percentage points and the Treo acquisition also reduced margins by 0.1 percentage points as 3M integrates that business. Operating income margins were 22.7 percent in the first nine months of 2014 compared to 21.8 in the first nine months of 2013, an increase of 0.9 percentage points. These results included a 1.1 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 selective restructuring. Foreign exchange impacts reduced operating income margins by 0.4 percentage points. Interest Expense and Income: Three months ended Nine months ended September 30, September 30, (Millions) 2014 2013 2014 2013 Interest expense $ 28 $ 33 $ 110 $ 113 Interest income (7 ) (10 ) (25 ) (30 ) Total $ 21 $ 23 $ 85 $ 83 Interest expense was lower in the third quarter and first nine months of 2014 compared to the same periods last year, primarily due to lower U.S. borrowing costs as debt maturities were replaced with lower cost financing from commercial paper and lower interest rates on new debt issuances. Capitalized interest related to property, plant and equipment construction in progress is recorded as a reduction to interest expense. The amounts shown in the table above for interest expense are net of capitalized interest amounts of $4 million, $7 million, $14 million, and $19 million, in the third quarter of 2014 and 2013, and for the nine months ended September 30, 2014 and 2013, respectively. Interest income in the third quarter and first nine months of 2014 was lower when compared to the same periods last year due to lower cash balances. Provision for Income Taxes: Three months ended Nine months ended September 30, September 30, (Percent of pre-tax income) 2014 2013 2014 2013 Effective tax rate 30.3 % 27.4 % 29.1 % 28.0 % The effective tax rate for the third quarter of 2014 was 30.3 percent, compared to 27.4 percent in the third quarter of 2013, an increase of 2.9 percentage points. Factors that increased the Company's effective tax rate on a combined basis by 3.3 percentage points year-on-year included a one-time international tax impact related to the establishment of the distribution center of expertise in Europe, increased domestic manufacturer's deduction in 2013, the 2013 restoration of tax basis on certain assets for which depreciation was previously limited, 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. Factors that decreased the Company's effective tax rate on a combined basis by 0.4 percentage points year-on-year included international taxes as a result of changes to the geographic mix of income before taxes. The effective tax rate for the first nine months of 2014 was 29.1 percent, compared to 28.0 percent in the first nine months of 2013, an increase of 1.1 percentage points. Factors which increased the Company's effective tax rate by 1.7 percentage points for the first nine 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, adjustments to the Company's income tax reserves, increased domestic manufacturer's deduction in 2013, the 2013 restoration of tax basis on certain assets for which depreciation was previously limited, a one-time international tax impact related to the establishment of the distribution center of expertise in Europe, and other items. This increase was partially offset by a 0.6 percentage point decrease in international taxes as a result of changes to the geographic mix of income before taxes. Refer to Note 5 for further discussion of income taxes. During 2014, the Company established a new manufacturing, supply chain, and distribution center of expertise in Europe. As a result of this establishment, the Company incurred jurisdictional tax charges related to the transfer of certain functions to the center of expertise. 58 -------------------------------------------------------------------------------- Table of Contents The Company currently expects that its effective tax rate for total year 2014 will be approximately 28.5 to 29.0 percent, with the high end of the range assuming the lapse of the U.S. research and development credit. 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. Net Income Attributable to Noncontrolling Interest: Three months ended Nine months ended September 30, September 30, (Millions) 2014 2013 2014 2013 Net income attributable to noncontrolling interest $ 8 $ 15 $ 42 $ 49 Net income attributable to noncontrolling interest represents the elimination of the income or loss attributable to non-3M ownership interests in 3M consolidated entities. The changes in noncontrolling interest amounts have largely related to Sumitomo 3M Limited (Japan), which was 3M's most significant consolidated entity with non-3M ownership interests. As discussed in Note 4, on September 1, 2014, 3M purchased the remaining 25 percent ownership in Sumitomo 3M Limited, bringing 3M's ownership to 100 percent. Thus, effective September 1, 2014, net income attributable to noncontrolling interest will be significantly reduced. The primary remaining noncontrolling interest relates to 3M India Limited, of which 3M's effective ownership is 75 percent. Currency Effects: 3M estimates that year-on-year currency effects, including hedging impacts, decreased net income attributable to 3M by approximately $10 million for the three months ended September 30, 2014 and decreased net income attributable to 3M by approximately $64 million for the nine months ended September 30, 2014. This estimate includes the effect of translating profits from local currencies into U.S. dollars and the impact of currency fluctuations on the transfer of goods between 3M operations in the United States and abroad. This estimate also includes year-on-year currency effects from transaction gains and losses, including both derivative instruments designed to reduce foreign currency exchange rate risks and the negative impact of converting Venezuelan bolivars into Euros and U.S. dollars, which 3M estimates on a combined basis increased net income attributable to 3M by approximately $7 million for three months ended September 30, 2014 and decreased net income attributable to 3M by approximately $18 million for the nine months ended September 30, 2014. Refer to Note 9 in the Consolidated Financial Statements for additional information concerning 3M's hedging activities. Significant Accounting Policies: Information regarding new accounting standards is included in Note 1 to the Consolidated Financial Statements. 59 -------------------------------------------------------------------------------- Table of Contents PERFORMANCE BY BUSINESS SEGMENT Disclosures related to 3M's business segments are provided in Note 13. The reportable segments are Industrial; Safety and Graphics; Electronics and Energy; Health Care; and Consumer. Corporate and Unallocated: In addition to these five operating business segments, 3M assigns certain costs to "Corporate and Unallocated", which is presented separately in the preceding business segments table and in Note 13. Corporate and Unallocated includes a variety of miscellaneous items, such as corporate investment gains and losses, certain derivative gains and losses, certain insurance-related gains and losses, certain litigation and environmental expenses, corporate restructuring charges and certain under- or over-absorbed costs (e.g. pension, stock-based compensation) that the Company may choose not to allocate directly to its business segments. Because this category includes a variety of miscellaneous items, it is subject to fluctuation on a quarterly and annual basis. Corporate and Unallocated operating expenses improved by $25 million and $65 million in the third quarter and first nine months of 2014, respectively, when compared to the same periods last year. A majority of this decrease was due to lower pension and postretirement benefit expenses, which declined year-on-year by $42 million and $121 million, respectively, when compared to the same periods last year. Of this reduction, $29 million and $87 million, respectively, was allocated to Corporate and Unallocated. In addition, the sale of certain real estate benefited the second and third quarter of 2014. Operating Business Segments: Each of 3M's five business segments is absorbing incremental investments in 2014 related to business transformation and global ERP implementation. This resulted in a 0.30 percentage point year-on-year reduction in operating income margins for each of the five business segments in both the third-quarter and first nine months of 2014 when compared to the same periods last year. Information related to 3M's business segments for the third quarter and first nine months of both 2014 and 2013 is presented in the tables that follow. Organic local-currency sales include both organic volume impacts plus selling price impacts. Acquisition impacts, if any, are measured separately for the first twelve months of the acquisition. The divestiture impacts, if any, foreign currency translation impacts and total sales change are also provided for each business segment. Any references to EMEA relate to Europe, Middle East and Africa on a combined basis. 60 -------------------------------------------------------------------------------- Table of Contents Industrial Business: Three months ended Nine months ended September 30, September 30, 2014 2013 2014 2013 Sales (millions) $ 2,772 $ 2,692 $ 8,363 $ 8,068 Sales change analysis: Organic local currency 4.2 % 6.2 % 4.6 % 4.1 % Acquisitions - 4.1 - 4.1 Translation (1.2 ) (1.7 ) (0.9 ) (1.6 ) Total sales change 3.0 % 8.6 % 3.7 % 6.6 % Operating income (millions) $ 616 $ 571 $ 1,851 $ 1,753 Percent change 7.9 % 0.2 % 5.6 % (0.2 )% Percent of sales 22.2 % 21.2 % 22.1 % 21.7 % The Industrial segment serves a broad range of markets, such as automotive original equipment manufacturer (OEM) and automotive aftermarket (auto body shops and retail), electronics, appliance, paper and printing, packaging, food and beverage, and construction. Industrial products include tapes, a wide variety of coated, non-woven and bonded abrasives, adhesives, advanced ceramics, sealants, specialty materials, 3M Purification Inc. (filtration products), closure systems for personal hygiene products, acoustic systems products, and components and products that are used in the manufacture, repair and maintenance of automotive, marine, aircraft and specialty vehicles. Third quarter of 2014: Sales in Industrial totaled $2.8 billion, up 3.0 percent in U.S. dollars. Organic local-currency sales increased 4.2 percent, and foreign currency translation reduced sales by 1.2 percent. On an organic local-currency basis, sales growth was led by aerospace and commercial transportation, 3M Purification Inc., automotive OEM, advanced materials, and industrial adhesives and tapes. Organic local-currency sales also grew in abrasive systems and automotive aftermarket. Organic local-currency sales declined in personal care. Geographically, organic local-currency sales increased 8 percent in the United States. U.S. growth was broad based, with strong performances in automotive aftermarket, abrasives, and industrial adhesives and tapes, along with aerospace and commercial transportation, and automotive OEM. Organic local-currency growth was 4 percent in Asia Pacific and 1 percent in EMEA, while Latin America/Canada declined 1 percent. Operating income was $616 million in the third quarter of 2014, an increase of 7.9 percent. Operating income margins increased by 1.0 percentage point to 22.2 percent. Operating income margins improved due to sales volume leverage, plus the combination of selling price increases and raw material costs decreases, partially offset by incremental investments. As indicated in the preceding Operating Business Segments section, each of 3M's five business segments is absorbing incremental investments in 2014 related to business transformation and global ERP implementation. This reduced margins in each of the businesses by approximately 0.3 percentage points year-on-year. First nine months of 2014: Sales in Industrial totaled $8.4 billion, up 3.7 percent in U.S. dollars. Organic local-currency sales increased 4.6 percent, and foreign currency translation reduced sales by 0.9 percent. On an organic local-currency basis, sales growth was led by 3M Purification Inc., aerospace and commercial transportation, automotive OEM, advanced materials, and abrasive systems. Organic local-currency sales also grew in industrial adhesives and tapes, and automotive aftermarket. Organic local-currency sales declined in personal care. Geographically, organic local-currency sales increased 5 percent in both the United States and Asia Pacific, 4 percent in EMEA, and 2 percent in Latin America/Canada. Operating income was $1.9 billion in the first nine months of 2014, an increase of 5.6 percent. Operating income margins increased by 0.4 percentage points to 22.1 percent. Operating income margins improved due to sales volume leverage, plus the combination of selling price increases and raw material cost decreases, partially offset by incremental investments as discussed in third quarter results. 61 -------------------------------------------------------------------------------- Table of Contents Safety and Graphics Business: Three months ended Nine months ended September 30, September 30, 2014 2013 2014 2013 Sales (millions) $ 1,448 $ 1,429 $ 4,365 $ 4,262 Sales change analysis: Organic local currency 3.1 % 8.0 % 4.1 % 3.9 % Acquisitions - 0.9 - 1.7 Translation (1.8 ) (2.3 ) (1.7 ) (2.0 ) Total sales change 1.3 % 6.6 % 2.4 % 3.6 % Operating income (millions) $ 340 $ 313 $ 1,011 $ 973 Percent change 8.8 % 7.0 % 3.9 % (1.7 )% Percent of sales 23.5 % 21.9 % 23.2 % 22.8 % The Safety and Graphics segment serves a broad range of markets that increase the safety, security and productivity of people, facilities and systems. Major product offerings include personal protection products; traffic safety and security products, including border and civil security solutions; commercial solutions, including commercial graphics sheeting and systems, architectural surface and lighting solutions, and cleaning and protection products for commercial establishments; and roofing granules for asphalt shingles. Third quarter of 2014: Sales in Safety and Graphics totaled $1.4 billion, up 1.3 percent in U.S. dollars. Organic local-currency sales increased 3.1 percent, and foreign currency translation reduced sales by 1.8 percent. On an organic local-currency basis, sales growth was led by personal safety, and traffic safety and security systems. Organic local-currency sales also grew in the commercial solutions business. Sales in the roofing granules business declined year-on-year. Organic local-currency sales increased 7 percent in the United States, 3 percent in Europe, were flat in Latin America/Canada, and declined 1 percent in Asia Pacific. Operating income in the third quarter of 2014 totaled $340 million, up 8.8 percent. Operating income margins were 23.5 percent of sales, compared to 21.9 percent in the third quarter of 2013. Operating income margins benefited from organic volume leverage plus selling price increases, partially offset by incremental investments related to business transformation and global ERP implementation, plus selective restructuring. First nine months of 2014: Sales in Safety and Graphics totaled $4.4 billion, up 2.4 percent in U.S. dollars. Organic local-currency sales increased 4.1 percent, and foreign currency translation reduced sales by 1.7 percent. On an organic local-currency basis, sales growth was led by personal safety. 3M also saw positive organic local-currency sales growth in commercial solutions, and traffic safety and security systems. Sales in the roofing granules business declined year-on-year. Organic local-currency sales increased 5 percent in both the United States and Europe, and 3 percent in both Asia Pacific and Latin America/Canada. Operating income in the first nine months of 2014 totaled $1.0 billion, up 3.9 percent. Operating income margins were 23.2 percent of sales, compared to 22.8 percent in the first nine months of 2013. Operating income margins were impacted by the same factors discussed in third quarter results. 62 -------------------------------------------------------------------------------- Table of Contents Electronics and Energy Business: Three months ended Nine months ended September 30, September 30, 2014 2013 2014 2013 Sales (millions) $ 1,500 $ 1,449 $ 4,233 $ 4,066 Sales change analysis: Organic local currency 4.3 % 3.8 % 4.9 % -% Translation (0.8 ) (1.3 ) (0.8 ) (1.2 ) Total sales change 3.5 % 2.5 % 4.1 % (1.2 )% Operating income (millions) $ 338 $ 300 $ 858 $ 733 Percent change 12.5 % 3.2 % 17.0 % (9.2 )% Percent of sales 22.5 % 20.7 % 20.3 % 18.0 % The Electronics and Energy segment serves customers in electronics and energy markets, including solutions that improve the dependability, cost-effectiveness, and performance of electronic devices; electrical products, including infrastructure protection; telecommunications networks; and power generation and distribution. This segment's electronics solutions include optical film solutions for the electronic display industry; packaging and interconnection devices; high-performance fluids and abrasives; high-temperature and display tapes; 3M™ Flexible Circuits, which use electronic packaging and interconnection technology; and touch systems products, which include touch screens, touch monitors, and touch sensor components. This segment's energy solutions include pressure sensitive tapes and resins; electrical insulation; infrastructure products that provide both protection and detection solutions; a wide array of fiber-optic and copper-based telecommunications systems; and renewable energy component solutions for the solar and wind power industries. Third quarter of 2014: Electronics and Energy sales totaled $1.5 billion, up 3.5 percent in U.S. dollars. Organic local-currency sales increased 4.3 percent, and foreign currency translation reduced sales by 0.8 percent. Organic local-currency sales increased approximately 8 percent in 3M's electronics-related businesses, with strong growth in both display materials and systems and in electronics materials solutions. In 3M's energy-related businesses, organic local-currency sales declined approximately 2 percent. Organic local-currency sales in the electrical markets business was flat, while telecommunications and renewable energy both declined year-on-year. On a geographic basis, organic local-currency sales increased 7 percent in Asia Pacific, 3 percent in the United States, and were flat in Latin America/Canada. Organic local-currency sales declined 6 percent in EMEA. Operating income increased 12.5 percent to $338 million in the third quarter of 2014. Operating income margins were 22.5 percent compared to 20.7 percent in the third quarter of 2013, helped by sales volume leverage. First nine months of 2014: Electronics and Energy sales totaled $4.2 billion, up 4.1 percent in U.S. dollars. Organic local-currency sales increased 4.9 percent, and foreign currency translation reduced sales by 0.8 percent. Organic local-currency sales increased approximately 8 percent in 3M's electronics-related businesses, with strong growth in display materials and systems. In 3M's energy-related businesses, organic local-currency sales increased approximately 1 percent, led by telecommunications. Organic local-currency sales growth was flat in the electrical markets business, while renewable energy declined. On a geographic basis, organic local-currency sales increased 7 percent in Asia Pacific, 6 percent in Latin America/Canada, and were flat in both the United States and EMEA. Operating income increased 17.0 percent to $858 million in the first nine months of 2014. Operating income margins were 20.3 percent compared to 18.0 percent in the first nine months of 2013, helped by sales volume leverage and actions taken to improve the portfolio over the last two years. 63 -------------------------------------------------------------------------------- Table of Contents Health Care Business: Three months ended Nine months ended September 30, September 30, 2014 2013 2014 2013 Sales (millions) $ 1,390 $ 1,328 $ 4,180 $ 3,975 Sales change analysis: Organic local currency 5.4 % 6.8 % 5.6 % 5.5 % Acquisitions 0.5 - 0.3 0.1 Translation (1.2 ) (1.3 ) (0.7 ) (1.3 ) Total sales change 4.7 % 5.5 % 5.2 % 4.3 % Operating income (millions) $ 432 $ 426 $ 1,293 $ 1,247 Percent change 1.4 % 6.7 % 3.7 % 2.9 % Percent of sales 31.0 % 32.1 % 30.9 % 31.4 % The Health Care segment serves markets that include medical clinics and hospitals, pharmaceuticals, dental and orthodontic practitioners, health information systems, and food manufacturing and testing. Products and services provided to these and other markets include medical and surgical supplies, skin health and infection prevention products, inhalation and transdermal drug delivery systems, dental and orthodontic products (oral care), health information systems, and food safety products. Third quarter of 2014: Health Care sales totaled $1.4 billion, an increase of 4.7 percent in U.S. dollars. Organic local-currency sales increased 5.4 percent, acquisitions added 0.5 percent, and foreign currency translation reduced sales by 1.2 percent. Organic local-currency sales grew in all businesses, with the strongest growth in drug delivery systems and health information systems. Acquisition sales growth related to the April 2014 purchase of Treo Solutions LLC, headquartered in Troy, New York. Treo Solutions LLC is a provider of data analytics and business intelligence to healthcare payers and providers. On a geographic basis, organic local-currency sales increased 9 percent in Asia Pacific, 6 percent in both Latin America/Canada and the United States, and 3 percent in EMEA. Health Care organic local-currency sales grew 11 percent in developing markets. Operating income increased 1.4 percent to $432 million. Operating income margins were 31.0 percent in the third quarter of 2014, compared to 32.1 percent in the third quarter of 2013, with acquisition impacts reducing operating income margins by 0.4 percentage points. The third quarter of 2013 included a gain from the sale of a non-strategic equity method investment, which benefited third-quarter 2013 operating income margins by 1.4 percentage points. First nine months of 2014: Health Care sales totaled $4.2 billion, an increase of 5.2 percent in U.S. dollars. Organic local-currency sales increased 5.6 percent, acquisitions added 0.3 percent, and foreign currency translation reduced sales by 0.7 percent. Organic local-currency sales grew in all businesses, with the strongest growth in drug delivery systems, health information systems, and critical and chronic care. On a geographic basis, organic local-currency sales increased 8 percent in both Asia Pacific and Latin America/Canada, 6 percent in the United States, and 2 percent in EMEA. Health Care organic local-currency sales grew 11 percent in developing markets. Operating income increased 3.7 percent to $1.3 billion. Operating income margins were 30.9 percent in the first nine months of 2014, compared to 31.4 percent in the first nine months of 2013, with acquisition impacts reducing operating income margins by 0.3 percentage points. As discussed in the third quarter results above, the gain from the sale of a non-strategic equity method investment benefited first nine months 2013 operating income margins by 0.5 percentage points. 64 -------------------------------------------------------------------------------- Table of Contents Consumer Business: Three months ended Nine months ended September 30, September 30, 2014 2013 2014 2013 Sales (millions) $ 1,177 $ 1,153 $ 3,395 $ 3,332 Sales change analysis: Organic local currency 3.1 % 4.2 % 3.3 % 3.6 % Divestitures - (0.2 ) (0.2 ) (0.1 ) Translation (1.0 ) (1.9 ) (1.2 ) (1.7 ) Total sales change 2.1 % 2.1 % 1.9 % 1.8 % Operating income (millions) $ 272 $ 247 $ 741 $ 719 Percent change 10.1 % 0.6 % 3.1 % 1.3 % Percent of sales 23.2 % 21.5 % 21.8 % 21.6 % The Consumer segment serves markets that include consumer retail, office retail, home improvement, building maintenance and other markets. Products in this segment include office supply products, stationery products, construction and home improvement products (do-it-yourself), home care products, protective material products, certain consumer retail personal safety products, and consumer health care products. Third quarter of 2014: Sales in Consumer totaled $1.2 billion, up 2.1 percent in U.S. dollars. Organic local-currency sales increased 3.1 percent, and foreign currency translation reduced sales by 1.0 percent. On an organic local-currency basis, sales growth was led by construction and home improvement. 3M also posted positive sales growth in its consumer health care and home care businesses. Sales in the stationery and office supplies business were down slightly year-on-year. On a geographic basis, organic local-currency sales increased 5 percent in Asia Pacific and 4 percent in the United States. Back-to-school sales were strong in the U.S. mass retail channel. Organic local-currency sales were flat in EMEA, and declined 2 percent in Latin America/Canada. Organic local-currency growth was 5 percent in developing markets. Consumer operating income was $272 million, up 10.1 percent from the third quarter last year. Operating income margins were 23.2 percent, compared to 21.5 percent in the same period last year, helped by strong sales in the construction and home improvement business. First nine months of 2014: Sales in Consumer totaled $3.4 billion, up 1.9 percent in U.S. dollars. Organic local-currency sales increased 3.3 percent, divestitures reduced sales by 0.2 percent, and foreign currency translation reduced sales by 1.2 percent. On an organic local-currency basis, sales growth was led by construction and home improvement. 3M also posted positive growth in its consumer health care and home care businesses. Sales in the stationery and office supplies business were down slightly. On a geographic basis, organic local-currency sales increased 6 percent in Asia Pacific, 3 percent in the United States, and 1 percent in both EMEA and Latin America/Canada. Organic local-currency growth was 7 percent in developing markets. Consumer operating income was $741 million, up 3.1 percent from the first nine months last year. Operating income margins were 21.8 percent, up slightly from 21.6 percent in the same period last year. 65 -------------------------------------------------------------------------------- Table of Contents FINANCIAL CONDITION AND LIQUIDITY 3M continues to manage towards a more optimized capital structure, financed with additional low-cost debt. The strength and stability of 3M's business model and strong free cash flow capability, together with proven capital markets access, enables 3M to implement this strategy while continuing to invest in its businesses. Organic growth remains the first priority, thus 3M will continue to invest in research and development, capital expenditures, and commercialization capability. In 2013, as a first step towards increasing capital deployment, 3M drew down its U.S. cash position to a minimum level and also reactivated its $3 billion commercial paper program. In 2014, 3M filed a new 'well-known seasoned issuer" shelf registration statement, and recommenced the Series F medium term notes program for future debt issuances. 3M considers net debt to be an important measure of liquidity and of its ability to meet ongoing obligations. This measure is not defined under U.S. generally accepted accounting principles and may not be computed the same as similarly titled measures used by other companies. The Company defines net debt as total debt less the total of cash, cash equivalents and current and long-term marketable securities. The following table provides net debt as of September 30, 2014 and December 31, 2013. September 30, December 31, (Millions) 2014 2013 Total Debt $ 7,344 $ 6,009 Less: Cash and cash equivalents and marketable securities 3,801 4,790 Net Debt $ 3,543 $ 1,219 In the first nine months of 2014, 3M continued to make progress towards better optimizing its capital structure through higher debt levels and increased capital deployment. Net debt increased $2.3 billion at September 30, 2014 when compared to December 31, 2013. Actions taken in the first nine months of 2014 that contributed to the net debt increase included the June 2014 issuance of $625 million of five-year notes due 2019 and $325 million of thirty-year notes due 2044 under the Series F medium term notes program, along with lower cash balances in the U.S. and international. In addition, 3M's outstanding commercial paper balance was $1.905 billion at September 30, 2014, compared to zero at December 31, 2013. In July 2014, 3M repaid 1.025 billion Euros of maturing Eurobond notes. 3M will continue to implement changes to its capital structure over time. For 2014 in particular, 3M expects to add leverage of $2 billion to $4 billion when compared to December 31, 2013, and as of September 30, 2014, 3M is tracking to the mid-point of that range. 3M's primary short-term liquidity needs are met through cash on hand and U.S. commercial paper issuances. 3M resumed commercial paper funding in July 2013 for the first time since late 2008. 3M expects to maintain a consistent presence in the market and believes it will have continuous access to the commercial paper market. 3M's commercial paper program permits the Company to have a maximum of $3 billion outstanding with a maximum maturity of 397 days from date of issuance. The Company has significant liquidity and generates ongoing cash flow, which have been used, in part, to repurchase shares and to pay dividends on 3M common stock. In addition, 3M's liquidity and cash flow enable it to meet currently anticipated growth plans, including funds for research and development, capital expenditures, working capital investments and acquisitions. At September 30, 2014, 3M had $3.8 billion of cash, cash equivalents and marketable securities, of which approximately $3.7 billion was held by the Company's foreign subsidiaries and approximately $100 million was held by the United States. Of the $3.7 billion, U.S. dollar-based cash, cash equivalents and marketable securities totaled $2.3 billion, or 62 percent, which was invested in money market funds, asset-backed securities, agency securities, corporate medium-term note securities and other investment-grade fixed income securities. At December 31, 2013, cash, cash equivalents and marketable securities held by the Company's foreign subsidiaries and in the United States totaled approximately $4.3 billion and $0.5 billion, respectively. The Company's total balance of cash, cash equivalents and marketable securities was $1.0 billion lower at September 30, 2014 when compared to December 31, 2013. 3M is able to manage the business with lower cash levels, particularly in the U.S., due to significant ongoing cash flow generation and proven access to capital markets funding throughout business cycles. At September 30, 2014, 3M had $7.3 billion of debt, which included $5.2 billion of long-term debt and $2.1 billion related to the current portion of long-term debt and other borrowings. Other borrowings included $1.9 billion of commercial paper. 66 -------------------------------------------------------------------------------- Table of Contents In August 2013, 3M repaid $850 million (principal amount) of medium-term notes. In November 2013, 3M issued an eight-year Eurobond for an amount of 600 million Euros (approximately $815 million carrying value at December 31, 2013). In June 2014, 3M issued $625 million aggregate principal amount of five-year fixed rate medium-term notes due 2019 and also issued $325 million aggregate principal amount of thirty-year fixed rate medium-term notes due 2044. In July 2014, 3M repaid 1.025 billion Euros of maturing Eurobond notes. The strength of 3M's capital structure and significant ongoing cash flows provide 3M proven access to capital markets. Additionally, the Company's maturity profile is staggered to help ensure refinancing needs in any given year are reasonable in proportion to the total portfolio. The Company has an AA- credit rating, with a stable outlook, from Standard & Poor's and an Aa2 credit rating, with a negative outlook, from Moody's Investors Service. In August 2014, Moody's Investor Service reaffirmed 3M's Aa2 credit rating, but changed 3M's outlook from stable to negative. The Company's ongoing transition to a more optimized capital structure, financed with additional low-cost debt, could impact 3M's credit rating in the future. In August 2014, 3M amended and extended the existing $1.5 billion five-year multi-currency revolving credit agreement to a $2.25 billion five-year multi-currency revolving credit agreement, with an expiration date of August 2019. This credit agreement includes a provision under which 3M may request an increase of up to $2.25 billion, bringing the total facility up to $4.5 billion (at the lenders' discretion). This facility was undrawn at September 30, 2014. In December 2012, 3M entered into a three-year 66 million British Pound (approximately $106 million based on agreement date exchange rates) committed credit agreement, which was fully drawn as of December 31, 2012. 3M repaid 36 million British Pounds in the first quarter of 2014, leaving a remaining balance due of 30 million British Pounds as of September 30, 2014. Apart from the committed facilities, an additional $219 million in stand-alone letters of credit and $22 million in bank guarantees were also issued and outstanding at September 30, 2014. These lines of credit are utilized in connection with normal business activities. Under the $2.25 billion credit agreement, the Company is required to maintain its EBITDA to Interest Ratio as of the end of each fiscal quarter at not less than 3.0 to 1. This is calculated (as defined in the agreement) as the ratio of consolidated total EBITDA for the four consecutive quarters then ended to total interest expense on all funded debt for the same period. At September 30, 2014, this ratio was approximately 59 to 1. Debt covenants do not restrict the payment of dividends. The Company has a "well-known seasoned issuer" shelf registration statement, effective May 16, 2014, which registers an indeterminate amount of debt or equity securities for future sales. This replaced 3M's previous shelf registration dated August 5, 2011. In June 2014, in connection with the May 16, 2014 shelf registration, 3M re-commenced its medium-term notes program (Series F) under which 3M may issue, from time to time, up to $9 billion aggregate principal amount of notes. Included in this $9 billion are $2.25 billion of notes previously issued in 2011 and 2012 as part of Series F. In June 2014, 3M issued $625 million aggregate principal amount of five-year fixed rate medium-term notes due 2019 with a coupon rate of 1.625%. Upon debt issuance, $600 million of this amount was converted to an interest rate based on a floating LIBOR index. In addition, in June 2014, 3M issued $325 million aggregate principal amount of thirty-year fixed rate medium-term notes due 2044 with a coupon rate of 3.875%. Both June 2014 debt issuances were from the medium-term notes program (Series F). In September 2011, in connection with the August 5, 2011 shelf registration statement, 3M established a $3 billion medium-term notes program (Series F), from which 3M issued a five-year $1.0 billion fixed rate note with a coupon rate of 1.375%. Proceeds were used for general corporate purposes, including repayment in November 2011 of $800 million (principal amount) of medium-term notes. In June 2012, 3M issued $650 million aggregate principal amount of five-year fixed rate medium-term notes due 2017 with a coupon rate of 1.000% and $600 million aggregate principal amount of ten-year fixed rate medium-term notes due 2022 with a coupon rate of 2.000%, which were both issued from this $3 billion medium-term notes program (Series F). Sources for cash availability in the United States, such as ongoing cash flow from operations and 3M's proven access to capital markets, have historically been sufficient to fund dividend payments to shareholders and share repurchases, in addition to funding U.S. acquisitions, U.S. capital spending, U.S. pension/other postemployment benefit contributions, and other items as needed. For those international earnings considered to be reinvested indefinitely, the Company currently has no plans or intentions to repatriate these funds for U.S. operations. However, if these international funds are needed for operations in the U.S., 3M would be required to accrue and pay U.S. taxes to repatriate them. In 2014, the Company plans to contribute approximately $200 million of cash to its pension and postretirement plans. The Company does not have a required minimum cash pension contribution obligation for its U.S. plans in 2014. Therefore, the amount of the anticipated discretionary contribution could vary significantly depending on the U.S. qualified plans' funded status as of the 2014 measurement date and the anticipated tax deductibility of the contribution. Future contributions will also depend on market conditions, interest rates and other factors. 3M believes its strong cash flow and balance sheet will allow it to fund future pension needs without compromising growth opportunities. 67 -------------------------------------------------------------------------------- Table of Contents 3M's strong balance sheet and liquidity provide the Company with significant flexibility to take advantage of numerous opportunities going forward. The Company will continue to invest in its operations to drive growth, including continual review of acquisition opportunities. In December 2013, 3M's Board of Directors declared a dividend of 85.5 cents per share for the first-quarter of 2014, an increase of 35 percent. This is equivalent to an annual dividend of $3.42 per share and marked the 56th consecutive year of dividend increases for 3M. In February 2014, 3M's Board of Directors also authorized the repurchase of up to $12 billion of 3M's outstanding common stock, which replaced the Company's February 2013 repurchase program. This authorization has no pre-established end date. As of September 30, 2014, approximately $7.9 billion remained available under the February 2014 repurchase authorization. Various assets and liabilities, including cash and short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. Working capital (defined as current assets minus current liabilities) totaled $4.976 billion at September 30, 2014, compared with $5.235 billion at December 31, 2013, a decrease of $259 million. Current asset balance changes decreased working capital by $52 million, with increases in accounts receivable and other items offset by a decrease in cash and cash equivalents. Current liability balance changes decreased working capital by $207 million, largely due to an increase in short-term debt partially offset by decreases in other current liabilities. The other current liabilities decrease largely related to the dividend declared in December 2013 that was not paid until March 2014 (discussed in Note 4). The Company uses various working capital measures that place emphasis and focus on certain working capital assets and liabilities. These measures are not defined under U.S. generally accepted accounting principles and may not be computed the same as similarly titled measures used by other companies. One of the primary working capital measures 3M uses is a combined index, which includes accounts receivable, inventories and accounts payable. This combined index (defined as quarterly net sales - fourth quarter at year-end - multiplied by four, divided by ending net accounts receivable plus inventories less accounts payable) was 4.7 at September 30, 2014 compared to 4.8 at December 31, 2013. Receivables increased $458 million, or 10.8 percent, compared with December 31, 2013, with higher September 2014 sales compared to December 2013 sales contributing to this increase. Currency translation impacts decreased accounts receivable by $138 million. Inventories increased $81 million, or 2.1 percent, compared with December 31, 2013, with the increases primarily attributable to an increase in demand in the first nine months of 2014, partially offset by currency translation, which decreased inventories by $151 million. Accounts payable had a minimal change when compared with December 31, 2013. Cash flows from operating, investing and financing activities are provided in the tables that follow. Individual amounts in the Consolidated Statement of Cash Flows exclude the effects of acquisitions, divestitures and exchange rate impacts on cash and cash equivalents, which are presented separately in the cash flows. Thus, the amounts presented in the following operating, investing and financing activities tables reflect changes in balances from period to period adjusted for these effects. Cash Flows from Operating Activities: Nine months ended September 30, (Millions) 2014 2013 Net income including noncontrolling interest $ 3,819 $ 3,605 Depreciation and amortization 1,058 1,014 Company pension contributions (107 ) (381 ) Company postretirement contributions (5 ) (4 ) Company pension expense 232 332 Company postretirement expense 61 82 Stock-based compensation expense 221 197 Income taxes (deferred and accrued income taxes) (25 ) (29 ) Excess tax benefits from stock-based compensation (121 ) (68 ) Accounts receivable (587 ) (643 ) Inventories (232 ) (155 ) Accounts payable 55 (26 ) Product and other insurance receivables and claims 50 37 Other - net 24 (137 ) Net cash provided by operating activities $ 4,443 $ 3,824 68 -------------------------------------------------------------------------------- Table of Contents Cash flows from operating activities can fluctuate significantly from period to period, as pension funding decisions, tax timing differences and other items can significantly impact cash flows. In the first nine months of 2014, cash flows provided by operating activities increased $619 million compared to the same period last year, driven by lower pension contributions and increases in net income including noncontrolling interest. The combination of accounts receivable, inventories and accounts payable increased working capital by $764 million in the first nine months of 2014, compared to increases of $824 million in the first nine months of 2013, consistent with prior year-on-year increases in working capital requirements due to increasing sales. Additional discussion on working capital changes is provided earlier in the "Financial Condition and Liquidity" section. Free Cash Flow (non-GAAP measure): In addition to net cash provided by operating activities, 3M uses free cash flow as a useful measure of performance and as an indication of the strength of the Company and its ability to generate cash. 3M defines free cash flow as net cash provided by operating activities less purchases of property, plant and equipment (which is classified as an investing activity). Free cash flow is not defined under U.S. generally accepted accounting principles (GAAP). Therefore, it should not be considered a substitute for income or cash flow data prepared in accordance with U.S. GAAP and may not be comparable to similarly titled measures used by other companies. It should not be inferred that the entire free cash flow amount is available for discretionary expenditures. Below find a recap of free cash flow for the nine months ended September 30, 2014 and 2013. Nine months ended September 30, (Millions) 2014 2013 Net cash provided by operating activities $ 4,443 $ 3,824 Purchases of property, plant and equipment (PP&E) (1,003 ) (1,122 ) Free Cash Flow $ 3,440 $ 2,702 Cash Flows from Investing Activities: Nine months ended September 30, (Millions) 2014 2013 Purchases of property, plant and equipment (PP&E) $ (1,003 ) $ (1,122 ) Proceeds from sale of PP&E and other assets 116 86 Acquisitions, net of cash acquired (94 ) - Purchases and proceeds from sale or maturities of marketable securities and investments, net 383 313 Other investing 20 21 Net cash used in investing activities $ (578 ) $ (702 ) Investments in property, plant and equipment enable growth across many diverse markets, helping to meet product demand and increasing manufacturing efficiency. Capital spending was $1.003 billion in the first nine months of 2014, compared to $1.122 billion in the first nine months of 2013. The Company expects 2014 capital spending to be approximately $1.5 billion to $1.6 billion, as 3M continues to invest to expand its businesses. In 2013, 3M continued its expansion of manufacturing capacity in key markets, including investments in the U.S., China, Germany, and Brazil. This included significant investments across 3M's many businesses, such as abrasives, industrial adhesives and tapes, advanced materials, electronics-related, infection prevention, and other businesses. 3M continued its investments in IT systems and infrastructure, including ongoing phased implementation of an ERP system on a worldwide basis over the next several years. In addition, 3M is sustaining existing facilities through general maintenance, cost reduction, and compliance efforts. 3M is striving to increase its manufacturing and sourcing capacity, particularly in developing economies, in order to more closely align its production capability with its sales in major geographic regions. The initiative is expected to help improve customer service, lower transportation costs, and reduce working capital requirements. 3M will continue to make investments in critical emerging markets, such as China, Brazil, Poland and India, including plans to establish and begin production in a new wholly-owned manufacturing entity in India to serve as a source of supply to 3M's business in India and in other countries. 69 -------------------------------------------------------------------------------- Table of Contents Proceeds from sale of PP&E and other assets totaled $116 million in the first nine months of 2014 compared to $86 million in the same period last year. Apart from the normal periodic sales of PP&E, the first nine months of 2014 included proceeds of $50 million related to the sale of real estate. Refer to Note 2 for information on acquisitions and divestitures. The Company is actively considering additional acquisitions, investments and strategic alliances, and from time to time may also divest certain businesses. Purchases of marketable securities and investments and proceeds from maturities and sale of marketable securities and investments are primarily attributable to asset-backed securities, agency securities, corporate medium-term note securities and other securities, which are classified as available-for-sale. Interest rate risk and credit risk related to the underlying collateral may impact the value of investments in asset-backed securities, while factors such as general conditions in the overall credit market and the nature of the underlying collateral may affect the liquidity of investments in asset-backed securities. The coupon interest rates for asset-backed securities are either fixed rate or floating. Floating rate coupons reset monthly or quarterly based upon the corresponding monthly or quarterly LIBOR rate. Each individual floating rate security has a coupon based upon the respective LIBOR rate +/- an amount reflective of the credit risk of the issuer and the underlying collateral on the original issue date. Terms of the reset are unique to individual securities. Fixed rate coupons are established at the time the security is issued and are based upon a spread to a related maturity treasury bond. The spread against the treasury bond is reflective of the credit risk of the issuer and the underlying collateral on the original issue date. 3M does not currently expect risk related to its holdings in asset-backed securities to materially impact its financial condition or liquidity. Refer to Note 6 for more details about 3M's diversified marketable securities portfolio, which totaled $1.872 billion as of September 30, 2014. Purchases of investments include additional survivor benefit insurance, plus cost method and equity investments. Cash Flows from Financing Activities: Nine months ended September 30, (Millions) 2014 2013 Change in short-term debt - net $ 1,935 $ 607 Repayment of debt (maturities greater than 90 days) (1,551 ) (853 ) Proceeds from debt (maturities greater than 90 days) 1,064 12 Total cash change in debt $ 1,448 $ (234 ) Purchases of treasury stock (4,373 ) (3,538 ) Proceeds from issuances of treasury stock pursuant to stock option and benefit plans 739 1,372 Dividends paid to stockholders (1,672 ) (1,307 ) Excess tax benefits from stock-based compensation 121 68 Purchase of noncontrolling interest (699 ) - Other - net (37 ) (4 ) Net cash used in financing activities $ (4,473 ) $ (3,643 ) Total debt at September 30, 2014 was $7.3 billion, up from $6.0 billion at year-end 2013. Total debt was 31 percent of total capital (total capital is defined as debt plus equity) at September 30, 2014, compared to 25 percent of total capital at year-end 2013. Changes in short-term debt for the nine months ended September 30, 2014 largely related to commercial paper issuances ($1.9 billion), but also included bank borrowings by international subsidiaries. Repayment of debt for the nine months ended September 30, 2014 primarily includes repayment of a Eurobond repaid in July 2014 totaling 1.025 billion Euros (approximately $1.4 billion carrying value), repayment of 36 million British Pound related to the three-year 66 million British Pound committed credit facility agreement entered into in December 2012, and repayment of other international debt. Proceeds from debt for the nine months ended September 30, 2014 primarily related to the June 2014 issuance of $625 million aggregate principal amount of five-year fixed rate medium-term notes due 2019 and $325 million aggregate principal amount of thirty-year fixed rate medium-term notes due 2044 (refer to Note 7 for more detail). In addition, proceeds from debt for the nine months ended September 30, 2014 also include bank borrowings by international subsidiaries and parent company debt. For the first nine months of 2013, changes in short-term debt primarily related to commercial paper activity. Repayment of debt in the first nine months of 2013 related to the August 2013 repayment of $850 million (principal amount) of medium-term notes. Repurchases of common stock are made to support the Company's stock-based employee compensation plans and for other corporate purposes. 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 authorization 70 -------------------------------------------------------------------------------- Table of Contents has no pre-established end date. In the first nine months of 2014, the Company purchased $4.373 billion of stock, compared to $3.538 billion in the first nine months of 2013. The Company expects full-year 2014 gross share repurchases will be in the range of $5.5 to $6.0 billion, compared to a previous range of $4.5 billion to $5.0 billion. For more information, refer to the table titled "Issuer Purchases of Equity Securities" in Part II, Item 5. The Company does not utilize derivative instruments linked to the Company's stock. Cash dividends paid to shareholders totaled $1.672 billion in the first nine months of 2014, compared to $1.307 billion in the first nine months of 2013. 3M has paid dividends each year since 1916. 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 is equivalent to an annual dividend of $3.42 per share and marked the 56th consecutive year of dividend increases. In addition to the items described below, other cash flows from financing activities may include various other items, such as distributions to or sales of noncontrolling interests, changes in cash overdraft balances, and principal payments for capital leases. On September 1, 2014, 3M purchased (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, or approximately $865 million at closing date exchange rates. Upon completion of this transaction, 3M owned 100 percent of Sumitomo 3M Limited. Approximately $694 million was reflected as a financing activity in the consolidated statement of cash flows while the remainder was recorded as a current liability (paid in October 2014). In April 2014, 3M purchased the remaining noncontrolling interest in a consolidated 3M subsidiary for an immaterial amount, which was classified as a financing activity in the consolidated statement of cash flows. In March 2013, 3M sold shares in 3M India Limited, a subsidiary of the Company, in return for $8 million. The noncontrolling interest shares of this subsidiary trade on a public exchange in India. This sale of shares complied with an amendment to Indian securities regulations that required 3M India Limited, as a listed company, to achieve a minimum public shareholding of at least 25 percent. As a result of this transaction, 3M's ownership in 3M India Limited was reduced from 76 percent to 75 percent. The $8 million received in the first quarter of 2013 was classified as other financing activity in the consolidated statement of cash flows. 71 -------------------------------------------------------------------------------- Table of Contents CAUTIONARY NOTE CONCERNING FACTORS THAT MAY AFFECT FUTURE RESULTS This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part I, Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to shareholders and in press releases. In addition, the Company's representatives may from time to time make oral forward-looking statements. Forward-looking statements relate to future events and typically address the Company's expected future business and financial performance. Words such as "plan," "expect," "aim," "believe," "project," "target," "anticipate," "intend," "estimate," "will," "should," "could" and other words and terms of similar meaning, typically identify such forward-looking statements. In particular, these include, among others, statements relating to † the Company's strategy for growth, future revenues, earnings, cash flow, uses of cash and other measures of financial performance, and market position, † worldwide economic and capital markets conditions, such as interest rates, foreign currency exchange rates, financial conditions of our suppliers and customers, and natural and other disasters affecting the operations of the Company or our suppliers and customers, † new business opportunities, product development, and future performance or results of current or anticipated products, † the scope, nature or impact of acquisition, strategic alliance and divestiture activities, † the outcome of contingencies, such as legal and regulatory proceedings, † future levels of indebtedness, common stock repurchases and capital spending, † future availability of and access to credit markets, † pension and postretirement obligation assumptions and future contributions, asset impairments, tax liabilities, information technology security, and † the effects of changes in tax, environmental and other laws and regulations in the United States and other countries in which we operate. The Company assumes no obligation to update or revise any forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events and trends that are subject to risks and uncertainties. Actual future results and trends may differ materially from historical results or those reflected in any such forward-looking statements depending on a variety of factors. Important information as to these factors can be found in this document, including, among others, "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the headings of "Overview," "Financial Condition and Liquidity" and annually in "Critical Accounting Estimates." Discussion of these factors is incorporated by reference from Part II, Item 1A, "Risk Factors," of this document, and should be considered an integral part of Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations." For additional information concerning factors that may cause actual results to vary materially from those stated in the forward-looking statements, see our reports on Form 10-K, 10-Q and 8-K filed with the SEC from time to time. |