Cummins Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing, not a standalone fourth-quarter report; selected unaudited quarterly figures are also disclosed. Cummins designs, manufactures, distributes and services engines, components and power-generation systems. In 2016 it reported four segments: Engine, Distribution, Components and Power Systems.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $17.509 billion | $19.110 billion |
| Gross margin | $4.452 billion; 25.4% of sales | $4.947 billion; 25.9% |
| Operating income | $1.928 billion; 11.0% of sales | $2.057 billion |
| Net income attributable to Cummins | $1.394 billion | $1.399 billion |
| Diluted EPS | $8.23 | $7.84 |
| Operating cash flow | $1.935 billion | $2.059 billion |
| Cash and marketable securities at year-end | $1.380 billion | $1.811 billion |
| Total debt at year-end | $1.856 billion | $1.639 billion |
| Working capital / current ratio | $3.382 billion / 1.78 | $4.144 billion / 2.09 |
Net income was nearly flat despite lower sales and gross margin. Lower volumes, unfavorable product mix and currency movements pressured gross margin; lower material costs, improved Distribution margins and lower warranty expense provided partial offsets. The effective tax rate fell to 24.6% from 27.4%. Operating cash flow declined by $124 million. Cash capital expenditures were $531 million; internal-use software investment was an additional $63 million.
In the reported fourth quarter, sales were $4.503 billion, net income attributable to Cummins was $378 million, and diluted EPS was $2.25. In fourth-quarter 2015, those figures were $4.766 billion, $161 million and $0.92, respectively; the 2015 quarter included impairment, restructuring and loss-contingency charges.
Material changes and capital allocation
- Revenue declined 8% year over year. Engine sales fell 10%, Components 6%, Power Systems 14%, and Distribution 1% (segment sales before intersegment eliminations).
- North American heavy-duty truck engine demand weakened; Engine heavy-duty sales fell 22% and unit shipments fell 31%. Power Systems sales declined across all product lines. Light-duty automotive sales rose 7%, partly reflecting Nissan pickup platform sales.
- 2016 included a $138 million loss-contingency charge, compared with $60 million in 2015. 2015 also included $211 million of light-duty diesel asset impairment and $90 million of restructuring charges.
- Cummins repurchased $778 million of stock and paid $676 million in dividends during 2016. The quarterly dividend was raised 5.1% to $1.025 per share in July.
- The debt-to-capital ratio rose to 20.6% from 17.5%; management attributed the increase to commercial paper borrowings and lower shareholders’ equity. The company had $212 million of commercial paper outstanding and $1.54 billion of available revolving credit capacity. Its leverage ratio was 0.75:1.0 against a 3.5:1.0 maximum covenant.
- Segment reporting was reorganized in 2016, combining Power Generation and high-horsepower engine businesses into Power Systems. Comparative segment results were recast for the reorganization; a revised shared-cost allocation methodology applied to 2016 but not prior periods.
Outlook, risks and contingencies
Management did not provide a quantified 2017 revenue or earnings forecast in the supplied filing text. It cited possible strength in North American pickup trucks and improvement in India on-highway markets, offset by expected declines in North American heavy- and medium-duty trucks, weak power generation, potential weakness in North American construction, continued weak Brazil and industrial/mining demand, and currency volatility. Management said demand in several markets had remained below replacement levels and expected improvement over time as in prior cycles.
- Emissions campaign: Cummins recorded cumulative charges of $198 million in 2015–2016 for its expected participation in a field campaign addressing failures in certain third-party aftertreatment systems on vehicles for one OEM. The campaign expanded after further testing; cost allocation remained under discussion, including pending litigation. Final costs may differ from the accrual. Cummins said it did not then expect EPA or CARB fines or penalties.
- Market and customer exposure: Markets are cyclical, and PACCAR represented 13% of 2016 sales. Cummins warned that lower demand, OEMs increasing in-house engine production, or financial distress at a major truck customer could materially affect results.
- Investee exposure: Cummins recognized $301 million of equity, royalty and interest income from investees; more than half of this income was from three China-based joint ventures that Cummins does not control.
- Other risks: Foreign exchange, commodity and supply disruption, product quality or recalls, emission-regulation changes, litigation, tax audits, pension assumptions, cybersecurity and geopolitical risks. Environmental remediation costs were not expected to be material, but legal outcomes cannot be assured.
- Pensions: Management expected approximately $134 million of defined-benefit pension contributions in 2017 and higher 2017 pension expense than in 2016.
- Accounting changes: The new lease standard was expected to materially increase balance-sheet assets and liabilities. Revenue-recognition adoption was expected to gross up sales and cost of sales for certain remanufactured-product core exchanges, changing gross-margin percentage but not gross-margin dollars; the amount was still being quantified.
Key investor verification points
- Track the emissions field campaign’s final scope, regulatory approvals, cost allocation, litigation outcome and cash payments against the $198 million recorded charge.
- Compare 2017 market trends and actual results with management’s stated risks, particularly North American truck production, power generation, Brazil, mining and currency effects.
- Review segment performance on a consistent basis, accounting for the 2016 segment realignment and changed cost-allocation methodology.
- Monitor operating cash flow, liquidity and leverage alongside share repurchases, dividends and pension contributions.
- Assess the durability of China joint-venture earnings and PACCAR-related sales concentration, and review the detailed financial-statement notes for contingencies, debt terms and accounting-standard impacts.