Cummins Inc. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. This is an annual report, not a standalone fourth-quarter filing; selected Q4 figures are included below. Amounts are U.S. dollars unless stated otherwise.
Business context
Cummins designs, manufactures, distributes and services diesel and natural-gas engines, power-generation systems and related components. Its four segments are Engine, Power Generation, Components and Distribution. The company serves customers in more than 190 countries through a global distributor and dealer network. Management described 2010 as a recovery year, particularly in China, India and Brazil, while developed-market recovery remained uneven.
Financial performance
| Metric | 2010 | 2009 |
|---|---|---|
| Net sales | $13.226 billion | $10.800 billion |
| Gross margin | $3.168 billion; 24.0% of sales | $2.169 billion; 20.1% of sales |
| Operating income | $1.602 billion | $682 million |
| Net income attributable to Cummins | $1.040 billion | $428 million |
| Diluted earnings per share | $5.28 | $2.16 |
| Cash flow from operations | $1.006 billion | $1.137 billion |
| Capital expenditures | $364 million | $310 million |
Sales rose 22%; management attributed the earnings improvement to higher volumes, improved pricing, lower warranty expense, stronger equity income from investees and the absence of 2009 restructuring charges. The 2010 gross-margin improvement was also supported by favorable material costs and currency. Operating cash flow declined, chiefly because inventory increased to support expected demand, pension contributions were higher and equity income exceeded cash distributions received.
At year-end, cash and cash equivalents were $1.023 billion and marketable securities were $339 million. Total debt was $843 million, including $709 million of long-term debt; debt was 14.4% of total capital, versus 14.9% a year earlier. Working capital was $3.029 billion and the current ratio was 1.93, down from 2.06. Cummins reported $1.208 billion available under its revolving facility, was compliant with its financial covenants, and disclosed leverage and interest-coverage ratios of 0.46:1 and 36.68:1, respectively.
Segment EBIT increased across all four segments: Engine $809 million (from $252 million); Power Generation $299 million (from $167 million); Components $278 million (from $95 million); Distribution $297 million (from $235 million). Engine remained the largest segment by sales. Growth in Distribution included acquisitions; excluding acquisitions, its sales and EBIT each rose 14%.
Fourth-quarter selected data: 2010 net sales were $4.139 billion, gross margin $984 million, net income attributable to Cummins $362 million and diluted EPS $1.84. The comparable 2009 figures were $3.400 billion, $773 million, $270 million and $1.36.
Material changes and unusual items
- International sales increased to 64% of consolidated sales from 52% in 2009. Emerging-market demand strengthened, but North American heavy-duty truck engine unit sales fell 61%, reflecting purchases ahead of the 2010 emissions-standard change; medium-duty truck shipments in North America fell 34%.
- The 2010 results included a $32 million pretax ($21 million after-tax) Brazilian tax recovery for prior-period overpayments and $2 million of flood-damage expense. The recovery was excluded from segment results.
- In 2009, results included $99 million of restructuring and other charges and a $12 million flood-recovery gain; substantially all terminations under the 2009 restructuring plan were complete by year-end 2010.
- Equity, royalty and interest income from investees rose to $351 million from $214 million. A substantial portion of net income depends on unconsolidated distributors and joint ventures that Cummins does not control.
- Cummins acquired the remaining 70% interest in Cummins Western Canada for approximately $71 million and acquired a majority interest in another North American distributorship. It also repurchased $241 million of shares and raised its quarterly dividend by 50% during 2010.
- Subsequent to year-end, Cummins agreed to sell certain exhaust-business assets for an expected $120–$130 million, with an estimated pretax gain of $70–$80 million. It also signed a non-binding letter of intent to sell certain light-duty filtration assets for an expected $70–$75 million, with an estimated pretax gain of $30–$35 million.
Outlook, risks and contingencies
For 2011, management expected continued growth in China, India and Brazil, but at a slower pace than in 2010, and improvement in North American truck and power-generation markets. Expected pressures included higher warranty costs from a greater mix of EPA 2010-compliant engines, increased product-development investment, slower growth at joint ventures during capacity expansion, and rising commodity costs. Planned 2011 capital expenditures were $600–$650 million; management expected an effective tax rate of about 30%, excluding discrete items, and pension contributions of approximately $130 million.
- Key risks include another economic downturn, cyclical end markets, customer and OEM concentration or reduced engine outsourcing, competition, commodity and foreign-exchange movements, and reliance on single-source suppliers (approximately 60–70% of part types).
- New engine platforms and emissions-control systems carry technical, recall, warranty and reputational risks. The filing reports 2010 software and aftertreatment campaigns involving approximately 11,400 and 6,310 engines, respectively.
- Approximately $218 million had been capitalized for a light-duty diesel engine platform; weaker customer commitments or projected volumes could require impairment.
- Global pension plans were 96% funded at year-end. Funding and expense remain sensitive to asset returns, discount rates and actuarial assumptions.
- The company disclosed ordinary-course litigation and environmental matters, including a disputed flood-insurance claim: $220 million claimed and $92 million recovered as of year-end. Management said it did not believe pending lawsuits were material individually or in aggregate, but could not assure that final outcomes would not materially affect results.
- Unrecognized tax benefits were $85 million; possible changes within 12 months were estimated to range from zero to $60 million, and 2011 audit settlements could significantly affect earnings.
Important facts for investors to verify
- Whether 2011 demand and production recoveries, especially in North America, translated into sales and cash generation as expected.
- How much of earnings growth was recurring versus dependent on investee income, the Brazilian tax recovery, acquisition effects and other unusual items.
- Whether inventory growth, pension contributions and planned capital spending continue to constrain operating cash flow and liquidity.
- Warranty claims, recall exposure and field performance of EPA 2010/2011 engine platforms, plus progress on the light-duty diesel platform and its customer commitments.
- Outcomes of the flood-insurance dispute, tax audits and other contingencies, and the terms and completion of the announced asset sales.
Management and the independent auditor reported effective internal control over financial reporting as of December 31, 2010; the auditor issued an unqualified opinion on the consolidated financial statements.