Cummins Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 29, 2019; comparisons are with the periods ended September 30, 2018. Amounts are in U.S. dollars.
Business context
Cummins designs, manufactures, distributes and services engines, powertrain components, power-generation systems and electrified and hydrogen-fuel-cell products. Its reportable segments are Engine, Distribution, Components, Power Systems and Electrified Power. The quarter reflected softer truck and construction demand in several international markets, partly offset by strength in North American power generation and distribution.
Financial performance
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Net sales | $5.768 billion | $5.943 billion | $17.993 billion | $17.645 billion |
| Gross margin | $1.494 billion; 25.9% | $1.551 billion; 26.1% | $4.667 billion; 25.9% | $4.191 billion; 23.8% |
| Operating income | $699 million | $803 million | $2.346 billion | $2.055 billion |
| Net income attributable to Cummins | $622 million | $692 million | $1.960 billion | $1.562 billion |
| Diluted EPS | $3.97 | $4.28 | $12.45 | $9.53 |
| Operating cash flow | Not presented for the quarter | Not presented for the quarter | $2.343 billion | $1.388 billion |
Q3 sales declined 3% and diluted EPS declined 7% year over year. Nine-month sales increased 2%, net income attributable to Cummins rose 25%, and diluted EPS rose 31%. Nine-month operating cash flow increased $955 million, reflecting higher earnings, lower working-capital cash use, and other changes.
For the first nine months, capital expenditures were $395 million and internal-use software investment was $50 million. Investing cash outflow was $829 million; financing cash outflow was $1.198 billion, including $562 million of dividends and $806 million of share repurchases.
Balance sheet, debt and liquidity
- At September 29, 2019, cash and cash equivalents were $1.560 billion and marketable securities were $303 million.
- Total debt was $2.661 billion, including $902 million of commercial paper; debt was 23.3% of total capital, compared with 23.1% at year-end 2018.
- Working capital was $3.503 billion and the current ratio was 1.52. Committed revolving credit capacity remaining after commercial paper was approximately $2.6 billion; an additional $200 million was available under other facilities.
- Inventory was $3.821 billion, up from $3.759 billion at December 31, 2018. The reported inventory turnover fell to 4.5 from 4.9.
Material changes and segment trends
- Q3 Engine segment sales fell 11% and EBITDA fell 16%, primarily on weaker truck and construction demand; the segment also recorded a charge related to ending production of the 5-liter ISV engine.
- Distribution sales rose 4% and EBITDA rose 20% in Q3, supported by North American power-generation demand, including data-center orders.
- Components sales fell 6% in Q3, while EBITDA was approximately flat. Power Systems sales increased 2%, but EBITDA declined 3%.
- Nine-month gross margin improved 2.1 percentage points, largely because 2018 included a $368 million engine-system campaign accrual; pricing and lower material costs also helped. Q3 gross margin declined 0.2 percentage points amid lower volumes and tariff impacts.
- Equity, royalty and interest income from investees declined to $68 million in Q3 from $90 million, and to $256 million for the first nine months from $315 million.
Outlook, commentary and notable items
- Management expected full-year 2019 effective tax rate of approximately 21.5%, excluding discrete items; estimated 2019 capital expenditures of $650–$700 million and internal-use software spending of $65–$75 million.
- Management cited continued strength in North American pickup trucks and stable power-generation markets, with increased data-center demand. Expected challenges included lower North American heavy-duty truck production, weaker China truck and construction demand, weak India conditions, softer North American construction and oil-and-gas markets, and U.S.–China tariffs and trade uncertainty. The filing does not provide a specific full-year revenue or EPS forecast.
- On September 9, Cummins acquired an 81% interest in Hydrogenics for $235 million, adding hydrogen-generation and fuel-cell products to Electrified Power. Purchase accounting remained preliminary; goodwill and intangible-asset valuations were subject to change.
- Cummins was conducting an internal review of emissions certification and compliance for pickup-truck applications after discussions with EPA and CARB concerning model-year 2019 RAM 2500/3500 engines. DOJ and SEC inquiries were also ongoing. A revised engine calibration was included in engines shipped since September 2019; the company said the outcome and potential financial effect could not yet be estimated and could be material.
- The remaining accrual for the earlier engine-system emissions campaign was $279 million at quarter-end; the company projected the campaign to be substantially complete by December 31, 2020. The total campaign charge, excluding supplier recoveries, was $410 million.
- In October 2019, after quarter-end, Cummins initiated a voluntary U.S. retirement program, with costs expected in Q4. It also repurchased an additional 1.6 million shares for $256 million through October 29.
Most important facts for investors to verify
- Progress, scope and possible financial consequences of the emissions certification review and related government inquiries.
- Whether the $279 million remaining engine-system campaign accrual adequately covers completion costs and timing.
- How weaker truck, construction and international markets, tariffs and currency movements affect sales and margins in subsequent quarters.
- Final Hydrogenics purchase-price allocation, including provisional goodwill and intangible-asset values.
- Cash deployment and liquidity: commercial-paper balance, share repurchases, dividends, planned capital spending and pension contributions.
- The filing reports a $19 million write-off charge associated with ending 5-liter ISV production in other operating expense, while segment commentary describes a $33 million charge; verify the precise classification and reconciliation in the filing exhibits or subsequent disclosures.