Cummins Inc. — Q1 2016 Form 10-Q
Business context and period. Global manufacturer and distributor of diesel and natural-gas engines, components, and power systems. The unaudited quarter ended April 3, 2016; comparison is with the three months ended March 29, 2015. Amounts are in U.S. dollars unless indicated.
Financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $4.291 billion | $4.709 billion | Down 9% |
| Gross margin | $1.056 billion; 24.6% | $1.195 billion; 25.4% | Down $139 million; 0.8 percentage point |
| Operating income | $470 million | $548 million | Down 14% |
| Net income attributable to Cummins | $321 million | $387 million | Down 17% |
| Diluted EPS | $1.87 | $2.14 | Down 13% |
| Operating cash flow | $263 million | $173 million | Up $90 million |
Lower sales volumes, unfavorable product mix and currency movements weighed on gross margin and earnings. Lower material and commodity costs, restructuring savings, and reduced SG&A and engineering expenses partly offset the pressure. EPS also benefited by $0.03 from fewer shares outstanding following repurchases.
Cash and marketable securities totaled $1.274 billion at quarter-end, versus $1.811 billion at December 31, 2015. Total debt was $1.830 billion, up from $1.639 billion; debt to total capital increased to 20.1% from 17.5%. Working capital was $3.551 billion and the current ratio was 1.91, compared with $4.144 billion and 2.09 at year-end. Cash declined by $796 million during the quarter, reflecting $388 million of investing outflows and $632 million of financing outflows, including $575 million of share repurchases and $170 million of dividends. The company reported $1.75 billion of available revolving credit capacity, reduced to $1.70 billion by commercial paper outstanding.
Material changes and segment performance
- Revenue declined across most businesses amid weaker global on-highway, industrial and power generation demand and unfavorable foreign exchange, which reduced sales by approximately 3%. U.S. and Canada revenue fell 10%; international revenue fell 8%.
- Engine segment sales fell 10% and EBIT fell 21%, reflecting weaker heavy-duty truck and industrial demand. Distribution sales fell 1%, but EBIT rose 8%, supported by North American distributor consolidation and improved margins.
- Components sales fell 5% and EBIT fell 11%. Power Generation sales fell 19% and EBIT fell 37%, principally from lower volumes and broad-based regional weakness.
- Effective April 2016, the company combined Power Generation with its high-horsepower engine business to form Power Systems; revised segment reporting was to begin in Q2 2016.
Outlook, risks and unusual items
- Management expected North American medium-duty truck and pickup demand to remain strong and demand in India to improve. It expected about $160 million of annualized savings from 2015 restructuring actions.
- Expected headwinds included declining North American heavy-duty truck production, weak power generation markets, continued weakness in Brazil, oil and gas and mining demand, and currency volatility. Additional facility closures or restructuring could result in charges. No full-year revenue or earnings guidance was provided in the supplied filing text.
- Management expected a 2016 effective tax rate of approximately 28.5%, excluding one-time items. Q1 2015 included an $18 million discrete tax benefit from a favorable audit settlement; Q1 2016 did not include discrete tax items.
- The company had recorded a $60 million charge in Q4 2015 for its expected participation in an emissions-related field campaign involving third-party aftertreatment systems. Final campaign cost remained uncertain and was not expected to be known before the second half of 2016; no EPA or CARB fines or penalties were then expected.
- 2015 workforce reductions affected approximately 1,900 employees and generated a $90 million charge. Substantially all terminations were complete; approximately $88 million was expected to be settled in cash, mostly by the end of September 2016.
- Ordinary-course litigation and environmental matters were disclosed. The company said it did not believe the lawsuits were material individually or in aggregate, but noted outcomes could still adversely affect results. Supplier minimum-purchase arrangements could entail approximately $141 million in penalties if purchases ceased; management did not anticipate paying them.
- Management identified market downturns, customer distress, emissions regulation, product recalls, supplier risks, foreign exchange, commodity costs, litigation, and pension asset performance among factors that could affect results.
Investor verification priorities
- Track whether weak truck, industrial, power generation, Brazil, oil and gas, and mining markets develop as management expected, and how currency affects sales and margins.
- Verify realization of the expected restructuring savings and whether further closures or charges occur.
- Follow the emissions campaign design, timing and final cost, as well as any regulatory developments.
- Review completion and final share count/cost of the $500 million accelerated share repurchase, and the effect of continued repurchases on liquidity and leverage.
- Monitor cash generation, working capital, debt and credit capacity alongside planned 2016 capital spending of $600–$650 million and pension contributions of approximately $146 million.