Cummins Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 28, 2015; comparisons are to the periods ended June 29, 2014. Figures are in millions of dollars except per-share amounts and percentages.
Business context and results
Cummins designs, manufactures, distributes and services engines, components and power-generation systems worldwide. Its reportable segments are Engine, Distribution, Components and Power Generation. Reported sales growth reflected, in significant part, consolidation of partially owned North American distributors.
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $5,015 | $4,835 | $9,724 | $9,241 |
| Gross margin | $1,332 | $1,205 | $2,527 | $2,304 |
| Gross margin % | 26.6% | 24.9% | 26.0% | 24.9% |
| Operating income | $723 | $612 | $1,271 | $1,125 |
| Net income attributable to Cummins | $471 | $446 | $858 | $784 |
| Diluted EPS | $2.62 | $2.43 | $4.76 | $4.26 |
Q2 operating margin was approximately 14.4% versus 12.7% a year earlier. Growth in gross margin, higher volumes and lower material and commodity costs helped results; unfavorable currency movements and higher SG&A partly offset improvement. Q2 sales rose 4%, while six-month sales rose 5%. Six-month sales to international markets were 39% of total, down from 44% a year earlier; international revenue declined 6%.
Cash flow, balance sheet and capital allocation
- Six-month operating cash flow was $569, down from $701. Management attributed the decline primarily to working-capital outflows of $459 versus $131 in the prior-year period.
- Capital expenditures were $247. Operating cash flow less capital expenditures was $322, compared with $456 in the prior-year period; this is a simple calculation, not a company-defined cash-flow measure.
- At June 28, cash, cash equivalents and marketable securities totaled $1,849, versus $2,394 at year-end. Current assets were $9,003 and current liabilities $4,053; working capital was $4,950 and the current ratio 2.22.
- Total debt was $1,677, down from $1,698 at year-end; debt to total capital was 17.0%, versus 17.3%. The company reported $1.7 billion available on its revolving facility and $277 million available under international and other domestic facilities.
- Six-month financing cash outflow was $829, including $514 of share repurchases and $280 of dividends. The 2012 repurchase authorization was completed; $340 was repurchased under the new $1 billion authorization in Q2.
Material changes and segment performance
- Engine: Segment sales increased 2% in Q2 and 2% year to date; EBIT rose 10% in Q2 and 2% year to date. North American heavy- and medium-duty demand improved, while industrial sales weakened, particularly in international construction, mining and marine markets.
- Distribution: Sales increased 21% in Q2 and 36% year to date, largely reflecting acquired North American distributors. EBIT declined 10% in Q2 and was approximately flat year to date; margins fell as acquired distribution businesses were dilutive and expenses rose.
- Components: Sales increased 9% in Q2 and 7% year to date; EBIT rose 21% and 19%, respectively, supported by higher volumes and lower material costs.
- Power Generation: Sales were up 1% in Q2 and 3% year to date. EBIT fell 7% in Q2 but rose 23% year to date. Management described power-generation markets overall as weak.
Equity, royalty and interest income from investees declined to $94 in Q2 from $105 and to $162 year to date from $195, partly because distributor earnings shifted into consolidated results. Prior-year results also included gains on distributor fair-value adjustments and marketable securities; these contributed to lower year-over-year other income in 2015.
Outlook, risks and unusual items
- Management expected continued growth in North American heavy- and medium-duty on-highway markets, strong North American light-duty demand, further growth for the new China ISG engine, and improving demand in some Indian markets. It planned two additional North American distributor acquisitions in Q3.
- Challenges cited for the remainder of 2015 included weak power-generation markets; Brazil and China weakness; uncertainty in Europe; currency volatility; weak oil-and-gas demand amid low crude prices; and possible further deterioration in mining markets if commodity prices weakened. No consolidated full-year sales or EPS guidance is stated in the provided filing text.
- Planned 2015 capital expenditures were $700–$800. The company expected to spend $150–$190 on North American distributor acquisitions and related debt retirements in Q3.
- The expected full-year effective tax rate was approximately 29.5%, excluding one-time items; reinstatement of the expired research tax credit could reduce it to 28.5%. The six-month 2015 rate included an $18 discrete benefit from a favorable federal audit settlement.
- The board authorized a 25% quarterly dividend increase, from $0.78 to $0.975 per share, in July 2015. The company expected $175 of global pension contributions in 2015 and pension costs of approximately $63 for the year.
- Warranty liability, including related deferred warranty revenue, was $1,384 at period-end versus $1,185 a year earlier. Management cited ordinary-course litigation, product and environmental claims, and Brazilian tax, labor and customs matters; it did not believe the lawsuits were material individually or in aggregate, but noted outcomes could adversely affect results.
- Other commitments included $67 of potential supplier penalties if specified minimum purchases ceased (not expected by management), $67 of platinum and palladium purchase commitments, and $69 of performance-related guarantees. On June 29, 2015, after quarter-end, Cummins acquired the remaining 20.01% of Cummins Central Power for $41, including debt retirement and a remaining future payment.
Most important facts for investors to verify
- How much of reported growth and margin improvement is sustainable organic performance versus distributor consolidation and favorable costs.
- Whether working-capital demands, particularly receivables and inventory, reverse and support cash generation in the second half.
- Execution and returns from planned distributor acquisitions, share repurchases, elevated capital spending and the higher dividend.
- Demand trends in Brazil, China, Europe, power generation, oil and gas, and mining, alongside foreign-currency effects.
- Developments in warranty claims, litigation and environmental matters, and the effect of the research-credit decision on the tax rate.