Cummins Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter ended June 29, 2014; the quarter and first half each comprised 13 and 26 weeks, respectively. Dollar amounts are in millions except per-share data.
Business context
Cummins designs, manufactures, distributes and services engines, engine-related components and power-generation systems. It reports Engine, Components, Power Generation and Distribution segments and serves markets worldwide through distributors and dealers.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $4,835 | $4,525 | $9,241 | $8,447 |
| Gross margin | $1,227; 25.4% | $1,153; 25.5% | $2,343; 25.4% | $2,110; 25.0% |
| Operating income | $612 | $610 | $1,125 | $1,024 |
| Net income attributable to Cummins | $446 | $414 | $784 | $696 |
| Diluted EPS | $2.43 | $2.20 | $4.26 | $3.69 |
| Operating cash flow | Not separately presented for the quarter | $701 | $960 |
Liquidity and debt: At June 29, cash and cash equivalents were $2,219 and marketable securities were $158. Working capital was $5,271 and the current ratio was 2.38, versus 2.57 at year-end 2013. Total debt, including current maturities, was approximately $1,690; debt-to-capital was 17.2%, versus 18.1% at December 31, 2013. Cummins reported $1.7 billion available on its revolving facility, net of letters of credit, plus $254 million available under other facilities. Cash and marketable securities totaled $2.377 billion.
First-half operating cash flow declined $259 to $701, mainly due to working-capital outflows, deferred-tax effects and higher pension contributions. Cash declined $480 during the half. Investing cash use was $463, including $193 for acquisitions; financing cash use was $756, including $430 of share repurchases and $229 of dividends.
Changes versus prior year
- Q2 sales rose 7% and first-half sales rose 9%. Management attributed growth mainly to stronger North American on-highway demand and consolidation of acquired North American distributors.
- Net income attributable to Cummins increased 8% in Q2 and 13% in the first half. Gross margin dollars increased, while Q2 gross margin percentage edged down 0.1 percentage point; first-half gross margin percentage improved 0.4 point.
- Components performed strongly: sales increased 15% in Q2 and 18% year to date; segment EBIT rose 36% and 38%, respectively. Distribution sales rose 30% and 26%, but EBIT as a share of sales fell to 10.2% in Q2 and 9.2% year to date, reflecting the lower-margin acquired business mix.
- Power Generation weakened: sales fell 9% in Q2 and 11% year to date; EBIT declined 20% and 32%, respectively. Engine sales increased 3% in Q2 and 7% year to date, though Q2 segment EBIT declined 8%.
- Higher SG&A, warranty costs and unfavorable currency effects partly offset volume and material-cost benefits. First-half diluted EPS also benefited about $0.05 from lower share count due primarily to repurchases.
Outlook, commentary and notable items
- Management expected continued gains in North American medium-duty truck and bus share and improving heavy-duty truck demand. Euro VI emissions requirements were expected to support aftertreatment sales.
- Expected challenges included weak power-generation markets, weak demand in India, Brazil economic weakness, uncertainty in some European markets, uneven enforcement of emerging-market emissions rules and currency volatility.
- For 2014, Cummins expected capital expenditures of $700–$800; planned $450–$550 in distributor acquisitions and debt retirements; and anticipated $205 in pension contributions. The full-year effective tax rate was expected to be about 28%, excluding one-time items.
- In July 2014, the board authorized a quarterly dividend increase from $0.625 to $0.78 per share and authorized up to $1 billion of additional repurchases after completion of the existing program.
- Acquisition-related remeasurement gains were $14 in Q2 and $20 in the first half, included in other income. Other income also included gains on marketable securities and changes in corporate-owned life-insurance cash value. These items contributed to reported earnings and should be distinguished from recurring operating performance.
- First-half warranty liability ended at $1,185. The filing describes ordinary-course litigation and environmental matters, including potential responsibility at waste sites, but says pending matters are not believed material individually or in aggregate; outcomes cannot be assured. Supplier minimum-volume arrangements could entail approximately $91 of penalties if purchases stopped, which management did not expect to pay. Commodity forward commitments were $42.
- Management identified market downturns, customer and supplier concentration, emissions regulation, product recalls, commodity and currency volatility, pension performance, cybersecurity, litigation, and successful integration of distributor acquisitions among material risks.
Important facts for investors to verify
- Whether North American truck demand and market-share gains continue, and whether weakness in power generation and international markets persists.
- Whether working capital, receivables and inventory normalize and operating cash flow recovers after the first-half decline.
- How acquired distributors affect recurring Distribution margins, cash needs and integration costs, apart from acquisition-related remeasurement gains.
- Whether warranty costs, product performance and other contingencies require additional charges or cash outlays.
- Execution of the stated 2014 capital, pension and acquisition plans, alongside increased dividends and the proposed additional buyback authorization.