Cummins Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; compared with the three months ended April 1, 2018. Cummins designs, manufactures, distributes and services engines, powertrain components, power-generation systems and electrified power products worldwide.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $6.004 billion | $5.570 billion | +8% |
| Gross margin | $1.532 billion; 25.5% | $1.200 billion; 21.5% | +28%; +4.0 percentage points |
| Operating income | $799 million | $530 million | +51% |
| Net income attributable to Cummins | $663 million | $325 million | More than doubled |
| Diluted EPS | $4.20 | $1.96 | +$2.24 |
| Cash from operations | $412 million | Cash used: $117 million | +$529 million |
Net margin was approximately 11.0%, versus 5.8% in the prior-year quarter. Earnings benefited from higher sales and margins, the absence of a prior-year emissions-campaign charge, fewer unfavorable discrete tax items, and a gain in the value of corporate-owned life insurance. Other income included a $37 million life-insurance gain, compared with a $4 million loss in Q1 2018. Offsetting factors included higher R&D and SG&A costs, lower investee income and unfavorable currency effects.
Operating cash flow improved in part because working-capital cash outflow was $302 million, versus $511 million a year earlier. Investing activities used $71 million and financing activities used $347 million. Capital expenditures, including internal-use software, were $129 million.
Balance sheet and liquidity
- Cash, cash equivalents and marketable securities totaled $1.574 billion at March 31, 2019.
- Total debt was $2.421 billion, including $709 million of commercial paper; debt-to-capital was 21.7%, down from 23.1% at year-end 2018.
- Working capital was $3.664 billion and the current ratio was 1.57. Available capacity was approximately $2.791 billion under revolving facilities, plus $187 million under other facilities.
- Inventory rose to $3.893 billion from $3.759 billion at year-end; inventory turnover declined to 4.5 from 4.9.
- The company paid $179 million in dividends and repurchased $100 million of stock during the quarter.
Comparative and segment developments
- U.S. sales increased 13%, while international sales excluding the U.S. and Canada increased 1%; international sales were 39% of total sales, compared with 42% a year earlier.
- Engine sales rose 8% and segment EBITDA increased 53%, with stronger North American truck and construction demand and the absence of a prior-year campaign charge.
- Distribution sales rose 8% and EBITDA increased 39%, led by North America and power-generation demand.
- Components sales rose 6% and EBITDA increased 43%, including the benefit of no repeat of the prior-year emissions-campaign charge.
- Power Systems sales were essentially flat and EBITDA declined 3%. Electrified Power remained in development, with $3 million in sales and a $29 million segment EBITDA loss.
Outlook, risks and unusual items
- Management expected strong North American medium- and heavy-duty truck demand, continued strength in power generation and construction, and strong mining markets. It anticipated declines in Chinese truck and construction markets, North American oil and gas, and continued weakness in marine markets.
- Management forecast a 2019 effective tax rate of approximately 21.5%, excluding discrete items; capital expenditures of $650–$700 million and internal-use software spending of $65–$75 million; and approximately $90 million of additional U.S. and U.K. pension contributions. Full-year net periodic pension cost was expected to be about $64 million. No full-year revenue or EPS forecast is stated in the provided filing text.
- Tariffs and prolonged trade disputes, foreign exchange, market cyclicality, emissions regulation, supply constraints, and Brexit-related uncertainty were identified as risks.
- Emissions review: On April 29, 2019, Cummins disclosed a formal review of its emissions-certification process for pickup-truck applications following discussions with the EPA and CARB concerning model-year 2019 RAM 2500 and 3500 engines. The review was preliminary; the company could not estimate the financial impact and warned that remediation could materially affect results, financial condition or cash flows.
- Existing campaign obligation: The engine-system campaign accrual was $410 million at March 31, 2019, with $346 million unpaid; campaigns were expected to be substantially complete by December 31, 2020. Total warranty accrual was $2.288 billion, versus $2.208 billion at year-end.
- Other contingencies include ordinary-course litigation and environmental matters. The company said it could not estimate maximum potential losses for indemnifications; it reported $52 million maximum potential loss on specified guarantees and $61 million of possible penalties under supplier minimum-purchase arrangements, which it did not expect to pay.
- Adoption of the lease standard added $450 million of operating lease assets and liabilities at January 1, 2019, without material net-income or cash-flow impact. The filing reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Developments, scope and potential cost of the pickup-truck emissions-certification review, including any regulator findings or remediation requirements.
- Whether the strong Q1 margins and earnings persist after adjusting for the prior-year $187 million emissions-campaign charge, tax-item comparison and life-insurance gain.
- Warranty and campaign accrual adequacy, supplier recoveries, cash payments and progress toward the stated campaign completion timing.
- Demand trends in North American trucks, China, oil and gas, and other end markets; tariff, currency and trade-dispute impacts.
- Working-capital conversion, inventory turnover, planned capital spending, pension contributions, and the refinancing or renewal of the $1.5 billion revolving facility due to expire in August 2019.