CUMMINS INC quarterly report, Q2 FY2009

Cummins Inc. — Form 10-Q Summary

Business context and reporting period. Cummins designs, manufactures, distributes and services engines, power-generation systems and related components. This unaudited filing covers the 13 weeks ended June 28, 2009, and the six months then ended; comparisons are with the corresponding 2008 periods. Unless stated otherwise, amounts are in millions of dollars.

Financial performance

Metric	Q2 2009	Q2 2008	Six months 2009	Six months 2008
Net sales	$2,431	$3,887	$4,870	$7,361
Gross margin	$448	$879	$893	$1,586
Operating income	$121	$468	$150	$787
Net income attributable to Cummins	$56	$293	$63	$483
Diluted EPS	$0.28	$1.49	$0.32	$2.46
Operating cash flow	Not separately presented	Not separately presented	$321	$406

• Q2 sales fell 37%; first-half sales fell 34%. Cummins attributed the declines primarily to the global downturn and lower demand and volumes across its markets.
• Gross margin declined 49% in Q2 and 44% in the first half. Gross margin as a percentage of sales fell 4.2 and 3.2 percentage points, respectively. Lower volume/mix was the largest stated driver, alongside higher warranty and material costs; improved pricing and lower production costs partly offset the declines.
• Operating income fell 74% in Q2 and 81% in the first half. SG&A and research, development and engineering expenses decreased in dollars, but rose as a percentage of sales.
• First-half net cash from operations was $321, versus $406 a year earlier. Investing used $109 and financing used $119; cash increased $108 to $534. Capital expenditures were $139. Cash flow was supported by working-capital reductions, including lower inventory.
• At June 28, cash and cash equivalents were $534 and marketable securities $17. Working capital was $2,259 and the current ratio 2.07. Total debt was $680, down $18 from year-end; debt was 15.9% of total capital. The company reported $1.06 billion available under its revolving credit facility, $175 million under international credit facilities and $66 million under its receivables program.
• Common dividends declared were $0.175 per share for Q2 and $0.35 for the first half. The stock-repurchase program was temporarily suspended in February to conserve cash.

Material changes and segment performance

• All four segments reported lower sales. Q2 segment EBIT was Engine $(4), Power Generation $41, Components $(10) and Distribution $55. Engine and Components moved to losses; Power Generation and Distribution remained profitable.
• Q2 segment sales fell 45% at Engine, 35% at Power Generation, 41% at Components and 20% at Distribution. Management cited broad-based weaker demand, with particularly steep declines in truck, industrial, turbocharger and fuel-system markets.
• International sales represented 56% of Q2 sales and 54% of first-half sales, compared with 61% and 59% a year earlier.
• First-half restructuring charges were $73 pretax ($48 after tax, or $0.24 per diluted share). Actions included reductions of approximately 850 professional and 2,600 hourly employees, facility downsizing and closures. Workforce reductions were substantially completed by June 28; management expected completion of actions by September 2009.

Outlook, commentary and risks

• Management expected global demand to remain weak for the rest of 2009, with some emerging markets possibly improving in the second half. It expected 2009 sales to be significantly below 2008, but provided no specific sales or earnings forecast.
• Management expected positive operating cash flow in 2009, planned capital expenditures of approximately $300–$350, and anticipated defined-benefit pension contributions of $125–$135 plus approximately $53 of other postretirement claims and premiums.
• If implemented successfully, professional restructuring actions were expected to generate approximately $50 of annualized savings. Management warned that further deterioration in demand could require additional restructuring and charges that it could not then estimate.
• Warranty liability was $958 at period-end. The filing describes higher-than-expected repair costs on certain midrange engines and a $53 first-half increase in estimates for pre-existing warranties.
• A dispute with insurers concerns flood damage at four Southern Indiana sites in 2008. Cummins documented a $199 claim ($116 expense and $83 capital), excluding a further business-interruption claim; it had incurred approximately $88 of expense and $42 of capital costs through June 28. Insurers challenged coverage and policy limits; Cummins said it remained confident it would recover a majority of amounts due.
• Chrysler’s bankruptcy and reorganization affected demand: the light-duty engine agreement was not assigned to the new company. Cummins continued discussions with Chrysler and other potential customers and warned that inability to find alternatives could put $171 of assets and $41 of commitments at risk of impairment or adverse impact.
• Other principal risks include prolonged recession and customer credit constraints, supplier and supply-chain disruption, emissions-compliance costs and execution, commodity and foreign-exchange volatility, pension-asset performance, product warranty or liability claims, litigation and environmental obligations. Cummins said it did not believe pending lawsuits were material individually or in aggregate, while cautioning that outcomes could still adversely affect results or cash flows.

Important facts for investors to verify

• Whether demand, volumes, pricing and margins stabilized after June 28, and whether management’s 2009 outlook and cash-flow expectations were achieved.
• Actual restructuring costs, completion timing and realized savings versus the approximately $50 annualized target.
• Warranty claim trends and whether further revisions to warranty estimates were required.
• Outcome and timing of the flood-insurance litigation, including recoveries against the $199 documented claim and any business-interruption claim.
• Developments in the light-duty engine program, Chrysler relationship and potential impairment of the identified $171 of assets and $41 of commitments.
• Cash generation, working-capital movements, liquidity-facility availability, debt levels and pension funding needs.