Cummins Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are to the three and six months ended July 1, 2018. Amounts are in U.S. dollars unless stated otherwise. Cummins designs, manufactures, distributes and services engines, powertrain components, power systems and electrified power products worldwide.
Financial results
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $6.221 billion | $6.132 billion | $12.225 billion | $11.702 billion |
| Gross margin | $1.641 billion; 26.4% | $1.440 billion; 23.5% | $3.173 billion; 26.0% | $2.640 billion; 22.6% |
| Operating income | $848 million | $722 million | $1.647 billion | $1.252 billion |
| Net income attributable to Cummins | $675 million | $545 million | $1.338 billion | $870 million |
| Diluted EPS | $4.27 | $3.32 | $8.47 | $5.27 |
| Operating cash flow | Not stated by quarter | $1.220 billion | $473 million |
- Q2 sales rose 1%; attributable net income rose 24% and diluted EPS rose 29%. First-half sales increased 4%, net income 54% and diluted EPS 61%.
- Gross margin improved 2.9 percentage points in Q2 and 3.4 points in the first half. Higher pricing and favorable mix helped; lower warranty campaign costs were a major year-over-year factor. R&D expense increased 15% in Q2 and 14% for the half.
- Segment EBITDA in Q2 increased at Engine ($416 million, +15%), Distribution ($172 million, +19%) and Components ($297 million, +25%); declined at Power Systems ($173 million, -7%); and was a loss of $33 million at Electrified Power. First-half segment EBITDA was $2.091 billion versus $1.597 billion.
- First-half operating cash flow increased by $747 million year over year, mainly reflecting higher earnings, increased dividends from equity investees, higher other long-term liabilities and lower working-capital requirements. Capital expenditures were $242 million, with a further $34 million spent on internal-use software.
Balance sheet, debt and liquidity
- At June 30, 2019, cash and marketable securities totaled $1.732 billion; working capital was $4.161 billion and the current ratio was 1.66.
- Total debt was $2.223 billion, down from $2.476 billion at year-end 2018; debt to total capital declined to 19.5% from 23.1%. Debt includes $434 million of commercial paper and $1.670 billion of long-term debt, including current maturities.
- Available revolving credit capacity was approximately $3.066 billion, plus $211 million under international and other domestic facilities. A $1.5 billion 364-day facility was due to expire in August 2019; management said it intended to renew or replace facilities to maintain similar aggregate capacity.
- First-half financing cash outflow was $711 million, including $358 million of dividends and $100 million of share repurchases. The Board raised the quarterly dividend 15% in July, from $1.14 to $1.311 per share.
Changes, outlook and material matters
- North American strength, particularly in on-highway markets and power-generation sales to data-center customers, offset weaker international demand. International sales were 38% of total sales versus 41% a year earlier; foreign exchange was a headwind.
- Management expected strong North American medium-duty and pickup demand, stable power-generation and mining markets, and strong construction markets in North America and Europe. It anticipated declining North American heavy-duty truck demand in the second half, weaker China truck and construction markets, weak marine and North American oil-and-gas markets, and continued U.S.-China tariff costs. Prolonged trade disputes and Brexit uncertainty were additional concerns.
- Management expected a 2019 effective tax rate of approximately 21.5%, excluding discrete items; 2019 capital expenditures of $650–$700 million and internal-use software spending of $65–$75 million. It expected full-year pension contributions of about $123 million and net periodic pension cost of about $64 million.
- Emissions review: Cummins was conducting a formal review of emissions certification and compliance for pickup-truck applications after discussions with EPA and CARB concerning model-year 2019 RAM 2500/3500 engines. The company could not estimate the financial impact and said outcomes or remediation could materially adversely affect results and cash flows.
- Warranty campaign: The 2018 engine-system campaign generated $368 million of charges in the first half of 2018, including $181 million in Q2; the campaign’s total charge was $410 million, with $309 million remaining accrued at June 30, 2019. Total warranty accrual was $2.338 billion, up from $2.208 billion at year-end.
- Acquisition: Cummins agreed to acquire Hydrogenics Corporation for enterprise value of approximately $290 million, subject to customary conditions and shareholder approval; closing was expected in Q3 2019.
- Other risks include market downturns, regulatory and product-recall exposure, trade and foreign-exchange changes, supplier risks, litigation and contingencies. The filing states that ordinary-course lawsuits were not believed material individually or in aggregate, but does not assure that future outcomes will be immaterial.
Important facts for investors to verify
- Developments, potential remediation costs and regulatory outcomes from the EPA/CARB emissions review.
- Warranty campaign spending, remaining accrual adequacy and new warranty claims; base warranty provisions were 2.1% of sales in the first half versus 1.9% a year earlier.
- Whether the expected second-half market declines, tariffs and international weakness affect sales, margins and cash generation.
- Completion, final terms and financial effects of the Hydrogenics acquisition, and renewal or replacement of the August 2019 credit facility.
- How much of the year-over-year earnings improvement reflects sustainable operating performance versus the absence of prior-year campaign charges and discrete tax items; first-half 2018 included $74 million of unfavorable discrete tax items.