Cummins Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 27, 2020; comparisons are to the periods ended September 29, 2019. Amounts are in U.S. dollars. Cummins designs, manufactures, distributes and services powertrains and related products, with Engine, Distribution, Components, Power Systems and New Power segments.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $5.118B | $5.768B | $13.981B | $17.993B |
| Gross margin | $1.349B; 26.4% | $1.494B; 25.9% | $3.533B; 25.3% | $4.667B; 25.9% |
| Operating income | $670M | $699M | $1.640B | $2.346B |
| Net income attributable to Cummins | $501M | $622M | $1.288B | $1.960B |
| Diluted EPS | $3.36 | $3.97 | $8.65 | $12.45 |
| Operating cash flow | $1.223B | $1.123B | $1.580B | $2.343B |
Margins and drivers: Q3 gross margin rate improved 0.5 percentage points, despite lower gross profit, mainly due to cost reductions, temporary salary cuts, lower material costs and a $44M Brazilian VAT recovery. Nine-month gross margin rate fell 0.6 points, reflecting lower volume and unfavorable mix, partly offset by cost reductions, lower warranty costs and the VAT recovery. Q3 net income was also pressured by higher variable compensation and taxes, unfavorable currency effects, and the absence of a $35M prior-year derivative-unwind gain.
Segment trends: Q3 total segment sales fell 11% and segment EBITDA fell 9%. Engine EBITDA rose 12%; Distribution fell 2%, Components fell 9%, Power Systems fell 36%, and New Power recorded a $40M EBITDA loss. For the first nine months, total segment sales fell 22% and segment EBITDA fell 26%; declines affected all segments, with Power Systems EBITDA down 43% and New Power recording a $121M loss.
Balance sheet, debt and liquidity
- At September 27, cash and cash equivalents were $2.967B; marketable securities were $345M, for combined cash and securities of $3.312B.
- Working capital was $5.353B and the current ratio was 1.94, versus $3.127B and 1.50 at year-end 2019.
- Total debt was $4.112B, up from $2.367B at December 31, 2019. Debt-to-capital increased to 32.2% from 21.9%.
- Available revolving credit capacity was $3.184B after commercial paper outstanding of $316M; an additional $191M was available under international and other domestic facilities. Management described total liquidity as approximately $6.5B, including cash, securities and available credit.
- In August, Cummins issued $2B of senior unsecured notes, receiving net proceeds of $1.98B: $500M due 2025 at 0.75%, $850M due 2030 at 1.50%, and $650M due 2050 at 2.60%. Credit ratings and stable outlooks were reaffirmed.
Nine-month investing cash outflow was $337M, including $268M of capital expenditures. Financing provided $564M, including the bond proceeds, while Cummins paid $582M of dividends and repurchased $550M of shares, all repurchased in Q1. Share repurchases were suspended in Q2 and Q3.
Outlook, commentary and risks
- Management provided no specific full-year revenue or earnings forecast in the supplied filing text. It said COVID-19 and its economic effects could continue to affect results, cash flows, customer demand, supply availability and facility operations through the remainder of 2020.
- The workforce-wide tiered payroll cuts ended September 30; management estimated this would add approximately $90M to Q4 expenses. The 2020 capital expenditure plan was reduced to $500M–$525M, excluding internal-use software; planned software spending was $50M–$60M.
- Management cited potential renewed facility shutdowns, supplier constraints or distress, reduced customer production, additional restructuring costs and continuing pandemic-related safety expenses. These impacts’ magnitude and duration were not predictable.
- A formal review of emissions certification and compliance for pickup-truck applications remains ongoing with EPA and CARB, with DOJ and SEC inquiries. Regulators raised concerns about emissions-system effectiveness; Cummins said it could not predict the outcome or estimate the financial impact, which could be material.
- The product warranty liability and related extended-warranty deferred revenue totaled $2.225B at quarter-end, including a $157M remaining accrual for the previously announced engine-system emissions campaign. The company also faces ordinary-course litigation and environmental claims; it said these were not believed material individually or collectively, while noting outcomes could still adversely affect results.
- Other unusual items included $31M of unfavorable discrete tax items in Q3 and $27M unfavorable net discrete tax items for nine months. India tax-law changes contributed a net favorable $35M income-statement impact for the nine-month period.
- The Board increased the quarterly dividend 3% to $1.35 per share in October 2020. The filing states disclosure controls were effective and there was no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether demand, production and supplier conditions recover or deteriorate after Q3, especially in North American on-highway, distribution and industrial markets.
- Progress and potential financial consequences of the emissions certification review and related regulator and agency inquiries.
- Whether the Q3 gross-margin-rate improvement is sustainable despite lower volumes, and how the end of temporary payroll cuts affects Q4 costs.
- Cash generation, debt growth and capacity to maintain dividends and planned investment amid continued market uncertainty.
- Warranty and campaign cost estimates, including the remaining $157M engine-system campaign accrual, and the eventual resolution of other legal and environmental matters.