Cummins Inc. Q1 2015 Form 10-Q
Reporting period: Three months ended March 29, 2015; comparative period ended March 30, 2014. Cummins designs, manufactures, distributes and services engines, components and power-generation systems globally. Its reportable segments are Engine, Distribution, Components and Power Generation.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $4.709 billion | $4.406 billion | +7% |
| Gross margin | $1.195 billion; 25.4% of sales | $1.099 billion; 24.9% | +9%; +0.5 percentage points |
| Operating income | $548 million | $513 million | +7% |
| Net income attributable to Cummins | $387 million | $338 million | +14% |
| Diluted EPS | $2.14 | $1.83 | +17% |
| Operating cash flow | $173 million | $263 million | -$90 million |
- SG&A was $517 million, or 11.0% of sales, versus $485 million and 11.0%. Research, development and engineering expense was $195 million, or 4.1% of sales, versus $190 million and 4.3%.
- Cash and cash equivalents were $1.997 billion; marketable securities were $115 million. Total debt was $1.706 billion. The debt-to-capital ratio was 17.5%, compared with 17.3% at year-end 2014.
- Working capital was $4.943 billion and the current ratio was 2.22. Cash, cash equivalents and marketable securities totaled $2.112 billion; the company also reported $1.7 billion available under its revolving credit facility.
- Cash declined $304 million during the quarter, including a $56 million adverse effect from exchange rates. Investing used $125 million and financing used $296 million.
- Capital expenditures were $100 million. Cummins paid $140 million in dividends and repurchased $137 million of shares. The quarterly dividend declared per share was $0.78, up from $0.625.
Material changes and operating drivers
- Revenue growth was driven mainly by consolidating partially owned North American distributors and stronger North American on-highway demand. U.S. and Canadian revenue rose 17%; international revenue excluding those markets declined 6%. Currency movements reduced sales by approximately 3%.
- Distribution sales rose 55% to $1.476 billion, largely due to distributor acquisitions. Segment EBIT increased to $88 million, but its margin fell to 6.0% from 8.0%, reflecting acquisition-related dilution.
- Components sales increased 6% and segment EBIT rose 17% to $195 million. Power Generation sales increased 6% and EBIT rose to $49 million. Engine sales increased 1%, while EBIT decreased 6% to $253 million.
- Higher gross margin reflected acquired Distribution sales, higher volumes and lower material and commodity costs, partly offset by higher warranty costs and unfavorable currency. Equity, royalty and interest income from investees fell $22 million, primarily because distributor earnings were consolidated rather than reported as equity income.
- Warranty liability increased to $1.320 billion from $1.283 billion at the start of the year. Warranty provision was 2.0% of sales versus 1.8% in the prior-year quarter.
- Other comprehensive loss was $164 million, principally due to foreign currency translation adjustments of $176 million, contributing to the increase in accumulated other comprehensive loss.
Outlook, risks and unusual items
- Management expected continued growth in North American heavy- and medium-duty on-highway markets, strong North American light-duty demand, and market-share gains in China for the ISG engine. It also expected improvement in some Indian end markets.
- Management identified weak power-generation markets, Brazil, China, parts of Europe, oil and gas, mining, emerging-market emissions enforcement and foreign-currency volatility as challenges for the remainder of 2015. No consolidated revenue or earnings forecast was stated in the supplied filing text.
- Planned 2015 capital expenditures were $750 million to $850 million. Management expected to spend a further $160 million to $200 million on North American distributor acquisitions and related debt retirements in the second half of 2015.
- Management expected a 2015 effective tax rate of approximately 29.5%, excluding one-time items; reinstatement of the expired research tax credit could reduce it to 28.5%. Q1’s 26.3% effective rate included an $18 million discrete benefit from a favorable federal audit settlement.
- Management expected $175 million of global pension contributions in 2015 and approximately $63 million of 2015 net periodic pension cost. Pension plans were 108% funded at December 31, 2014.
- Legal matters include product, warranty, intellectual-property, tax, workplace and environmental claims. The company said it did not believe pending lawsuits were material individually or in aggregate, while noting that final outcomes could adversely affect results. Supplier minimum-purchase arrangements carried approximately $70 million in potential penalties if purchases ceased; management did not anticipate paying them. Commodity forward-contract commitments were $55 million.
- Q1 results included a roughly $12 million impairment charge recorded by an equity investee, reflected in lower equity earnings. The filing also cites market, customer, supply-chain, regulatory, currency, pension, litigation and cybersecurity risks.
Important facts for investors to verify
- Whether acquired distributor revenue and earnings, including the margin dilution, meet expectations as further acquisitions proceed.
- Whether weaker international end markets, currency effects and lower oil-and-gas and mining demand affect future sales and profitability.
- Whether warranty costs remain elevated and whether the increased warranty liability adequately reflects expected claims.
- Whether working-capital demands and pension contributions constrain operating cash flow, given the quarter’s lower cash generation.
- How the $18 million discrete tax benefit affects comparability of Q1 earnings and whether the research tax credit is renewed.
- Progress on planned distributor acquisitions, capital spending, share repurchases and the company’s stated liquidity and debt position.