Large, diversified companies like 3M (MMM -0.96%) face lawsuits all the time; it's really just part of the business. However, 3M is dealing with a couple of particularly nasty lawsuits that could end up being very costly. To help investors get an idea of just what's going on, management changed the way it reports earnings. Here's a quick look at what's going on.
The quick overview
Industrial giant 3M makes a lot of products, and it makes them the world over. That means that it has a broadly diversified portfolio, but also that there are a lot of things that could go wrong. Right now, it is dealing with some notable things that have gone wrong.
For example, it historically used chemicals in some of its plants that are now viewed as environmental problems. It has been working to clean up after itself, and predecessor companies, but it is still facing legal costs around the effort. At the same time, it is fighting lawsuits around earplugs that it sold to the U.S. military. Users of the devices say they were faulty, while 3M is countering that any problems relate to user error. Neither of these are small issues.
For example, 3M just lost a case around the earplugs. It has been ordered to pay $77.5 million to a single person. There are hundreds of thousands of U.S. veterans lined up to sue the company, so this could get costly quick. The company is appealing the cases it loses and has actually won some along the way, so the final financial outcome isn't clear.
Putting some numbers on it
However, there are two big numbers that investors need to be thinking about. The first is obviously the cost that could come if 3M ultimately ends up paying money in a settlement. Although unknown, the industrial giant has an $85 billion market cap and an investment-grade rated balance sheet. It should be able to handle the costs here on the environmental and product liability side, noting that pushing the company into bankruptcy court wouldn't help those seeking money. The other cost is ongoing in that fighting in court requires spending money.
To help investors, 3M has changed its definition of adjusted earnings, allowing it to pull out legal and environmental issues as separate items. The numbers for the first quarter weren't exactly good reading. Using generally accepted accounting principles (GAAP), 3M earned $2.26 per share in the first quarter of 2022. The company's adjusted earnings totaled $2.65 per share. So the legal and environmental issues were a hefty $0.39 per share.
On the environmental front, where costs tend to be episodic and not ongoing, the company paid out $0.26 per share in the first quarter. There was no similar expense in the fourth quarter or the year-ago period.
On the legal front, the company paid $0.13 per share in the first quarter, which was down from $0.18 in the year-ago period and a penny lower than the fourth quarter of 2021. This cost will likely show up every quarter until the earplug issue is resolved in some fashion.
Now, as an investor, there are really two important takeaways here. The first is that you can see the costs 3M is facing and make a more-informed investment decision. But there's also the risk that adjusted earnings, removing these very real costs from the total, start to receive more focus than GAAP earnings. So if you aren't careful, the company's move to show the legal and environmental costs it is facing could end up obscuring the risk instead of helping to highlight it.
Play the right game
The big reveal between GAAP earnings and the new definition of adjusted earnings for 3M is that the company is facing very real and very large costs right now. The legal and environmental hit isn't going to go away quickly, either.
But don't let this reporting shift sneak in and refocus your attention on how 3M's business would perform without these costs. It is worth repeating that these costs are real, they are ongoing, and they are material. Adjusted earnings can be helpful, but you have to make sure you use them appropriately, particularly at 3M today.