Oshkosh Corporation — Q2 FY2011 Form 10-Q
Reporting period: Quarter and six months ended March 31, 2011. Results are unaudited; the company cautions that interim results are not necessarily indicative of the full year. Dollar amounts are in millions except per-share data.
Financial performance
| Metric | Q2 FY2011 | Q2 FY2010 | Six months FY2011 | Six months FY2010 |
|---|---|---|---|---|
| Net sales | $1,745.6 | $2,864.2 | $3,446.4 | $5,298.3 |
| Gross income | $281.1 | $627.8 | $590.1 | $1,107.0 |
| Operating income | $132.4 | $494.3 | $301.1 | $820.0 |
| Net income attributable to Oshkosh | $67.9 | $292.6 | $167.5 | $462.2 |
| Diluted EPS | $0.74 | $3.22 | $1.83 | $5.09 |
| Operating margin | 7.6% | 17.3% | 8.7% | 15.5% |
Gross margin was approximately 16.1% in Q2 and 17.1% for the first six months, versus 21.9% and 20.9%, respectively, in the comparable periods. The company attributed the deterioration principally to the transition from high-margin M-ATV production, lower-volume fixed-cost under-absorption, adverse product mix and increased product-development spending.
For the six months, operating cash flow was $256.6, down from $765.3. Investing activities used $26.7; financing activities used $156.5, including $165.3 of debt repayments. Cash increased $77.7 to $416.7.
At March 31, 2011, total debt was $1,136.9, down from $1,302.3 at September 30, 2010; debt to total capitalization declined to 42.4% from 49.5%. The company had $467.0 of unused revolving-credit capacity. Current assets were $2,102.0 and current liabilities $1,463.8. It reported compliance with credit covenants and expected to maintain compliance over the next 12 months.
Changes versus prior comparable periods
- Consolidated sales fell 39.1% in Q2 and 35.0% in the first half, mainly as M-ATV production and related intersegment activity wound down. M-ATV vehicle and parts/service sales were $248.8 in Q2, down $1.38 billion year over year; first-half sales were $763.8, down $1.97 billion.
- Defense sales declined 57.2% in Q2 and 49.5% year to date. Defense operating income fell to $141.6 in Q2 and $359.5 for the first half, reflecting lower M-ATV volume and FMTV ramp-up costs.
- Access equipment sales to external customers increased 72.7% in Q2 and 55.0% in the first half, supported by replacement demand and emerging-market growth. Segment operating income nevertheless fell to $17.7 in Q2 and $1.0 year to date, in part because prior-year results included substantial, high-single-digit-margin M-ATV intersegment sales.
- Fire & emergency sales declined 17.2% in Q2 and 13.8% in the first half; the segment recorded operating losses of $6.6 and $4.0, respectively, amid weak municipal spending, mix and restructuring costs.
- Commercial sales rose 3.9% in Q2, but were down 9.9% for the first half. The segment recorded Q2 operating income of $5.3 and a first-half operating loss of $2.4.
- Net interest expense fell to $20.7 in Q2 and $46.4 for the first half, primarily because of lower average debt and lower rates after the September 2010 refinancing.
Outlook, commentary and notable items
- Management expects second-half FY2011 operating and net income to be below first-half levels, which benefited from $763.8 of M-ATV-related sales. It nevertheless expects the company to remain profitable in both Q3 and Q4.
- FY2011 defense sales are forecast at $4.1–$4.2 billion, $300 million below the prior outlook, partly because of delayed government-budget timing and removal of the M-ATV ambulance order from the sales estimate. Full-year defense operating margin is expected in the low double digits; second-half margins are expected to be significantly lower than first-half margins.
- FMTV production start-up costs were $13.5 in Q2, causing a program loss. Further, lower start-up costs and further program losses are expected in Q3 and Q4. Management expects FMTV production and sales beyond FY2011 to be profitable, but warns that a 1% increase in material costs versus its estimate for FMTV backlog would add about $21 million of cost and that changed assumptions could require a material loss-contract charge.
- Management expects access equipment sales to external customers to post solid year-over-year gains, with low-single-digit segment margins; additional access-equipment restructuring charges of $2–$7 are expected. Fire & emergency sales are expected to decline for the year, with second-half profitability but lower full-year margins; about $5 of additional restructuring charges are expected. Commercial sales and margins are expected to be slightly lower than FY2010.
- FY2011 capital expenditures are expected to be $100–$110; the effective tax rate is expected to approximate 36%. No specific quantitative guidance for overall FY2011 earnings was provided.
- A Q2 estimate revision on an M-ATV undefinitized change order increased revenue and operating income by $15.2, and net income by $9.6, or $0.10 per share, because related costs had already been expensed. The filing also reports favorable M-ATV warranty experience.
- Backlog was $6.16 billion, up 21.2% year over year; approximately 49% was not expected to be filled in FY2011. A $161.6 M-ATV ambulance award remained in backlog despite a government stop-work order; the company removed the related sales from its defense outlook.
Risks and contingencies
- Key risks include lower or delayed U.S. defense procurement, contract competition or termination, and the high dependence on government business (59% of first-half sales were to the U.S. government). The FMTV ramp-up, delivery performance, cost estimates and possible loss of performance-based payments are material uncertainties.
- Access equipment, commercial and fire & emergency markets remain cyclical and exposed to weak construction activity, tight credit and constrained municipal spending. Commodity costs, supplier disruptions—including potential effects from Japan’s earthquake and tsunami—and labor matters, including the UAW contract expiration in September 2011, could affect operations.
- Credit guarantees for others totaled $194.3, with estimated maximum loss exposure of $64.2 and a recorded liability of $10.1. The company also reported $43.8 of product and general liability reserves and $2.2 of environmental reserves. Management did not expect the identified matters to have a material adverse effect, but outcomes remain uncertain.
- Other exposures include variable-rate debt, covenant restrictions, customer and receivable concentration, restructuring execution, warranty claims and possible future impairment charges. The company was not involved in legal proceedings reported under Part II, Item 1.
- Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether FMTV deliveries, start-up costs and material-cost assumptions support management’s expectation of post-FY2011 profitability—and whether the program avoids a loss-contract charge.
- Actual U.S. government orders, funding and delivery timing, including the M-ATV ambulance stop-work order and the potential for delayed or competitively bid programs.
- Whether access-equipment recovery and backlog convert into sales and margins, and whether fire & emergency and commercial results improve as forecast.
- Cash conversion and working-capital needs as M-ATV activity declines, alongside debt reduction, available revolver capacity and covenant headroom.
- Potential changes in guarantee, warranty, tax and restructuring exposures, and whether supplier or labor disruptions affect production.