Cummins Inc. — Q3 2018 Form 10-Q
Reporting period: Third quarter ended September 30, 2018; comparisons are with the quarter ended October 1, 2017. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data.
Business context and performance
Cummins designs, manufactures, distributes and services engines and related components, power systems and electrified power solutions worldwide. All operating segments reported higher sales in the quarter. Growth reflected stronger North American truck demand, global construction activity, distribution sales and power generation demand; international sales were partly offset by unfavorable currency effects.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | First nine months 2018 | First nine months 2017 |
|---|---|---|---|---|
| Net sales | $5,943 | $5,285 | $17,645 | $14,952 |
| Gross margin | $1,551; 26.1% | $1,341; 25.4% | $4,191; 23.8% | $3,724; 24.9% |
| Operating income | $803 | $622 | $2,055 | $1,748 |
| Net income attributable to Cummins | $692 | $453 | $1,562 | $1,273 |
| Diluted EPS | $4.28 | $2.71 | $9.53 | $7.60 |
| Cash from operations | Not separately presented for the quarter | $1,388 | $1,471 |
Quarterly sales rose 12%, net income attributable to Cummins rose 53%, and diluted EPS rose 58%. For the first nine months, sales rose 18%, net income rose 23%, and diluted EPS rose 25%. Nine-month gross margin declined 1.1 percentage points, principally reflecting the emissions campaign charge. Q3 gross margin improved 0.7 points, supported by volume, mix and lower campaign accruals compared with the prior-year quarter.
At September 30, 2018, cash, cash equivalents and marketable securities totaled $1.407 billion. Total debt was $2.465 billion, including $800 million of commercial paper; the debt-to-capital ratio was 23.4%, versus 19.7% at year-end 2017. Working capital was $3.447 billion and the current ratio was 1.54. The company reported $2.7 billion of available revolving credit capacity after commercial paper outstanding and was in compliance with its debt covenants.
Material changes and notable items
- Operating cash flow was $1.388 billion for the first nine months, down $83 million year over year. Higher working-capital needs, particularly inventory, and lower deferred income taxes more than offset higher earnings and lower pension contributions.
- Investing cash outflow was $519 million and financing cash outflow was $960 million. Capital expenditures, including internal-use software, were $416 million. Cash dividends paid were $537 million; share repurchases used $879 million of cash, including the $500 million accelerated share repurchase agreement.
- The Engine System Campaign resulted in $368 million of charges during the first half of 2018 for expanded emissions-related repairs to certain 2010–2015 engine systems. The remaining accrual was $396 million at quarter-end; campaigns were expected to be substantially complete by December 31, 2020.
- Q3 income tax expense included $37 million of favorable net discrete items ($0.23 per share). The first nine months included $37 million of unfavorable net discrete items. The company’s provisional accounting for the 2017 Tax Act remained subject to finalization.
- Cummins acquired Efficient Drivetrains, Inc. for $65 million in August 2018. Electrified Power recorded a $30 million Q3 EBITDA loss and a $61 million loss for the first nine months, reflecting development investment and early-stage operations.
Outlook, risks and contingencies
Management expected North American medium- and heavy-duty truck and pickup demand, power generation and global construction markets to remain strong for the remainder of 2018. Challenges included trade tariffs and potential prolonged trade disputes, expected declines in China truck demand, a North American oil and gas slowdown, and weak marine markets. Management expected the full-year 2018 effective tax rate to be approximately 21%, excluding discrete items, and planned $730–$760 million of capital expenditures for 2018.
Key risks cited include market downturns, emissions regulation and product issues, recalls and warranty costs, supply constraints, commodity and currency volatility, trade policy, competition and technology shifts, litigation, and political and regulatory risks in international markets. The filing describes ordinary-course litigation and environmental matters; the company said it did not believe these proceedings were material individually or in aggregate, while noting outcomes could still adversely affect results. Potential supplier penalties were approximately $80 million if purchases stopped; the company did not anticipate paying them.
The company entered into a new $2 billion five-year revolving facility and a $1.5 billion 364-day facility in August 2018. It also disclosed an October 2018 authorization for up to $2 billion of additional share repurchases after completion of the existing plan. The new lease accounting standard was expected to add $490–$540 million of operating lease assets and liabilities from January 2019, with an immaterial income-statement impact.
Important facts for investors to verify
- Progress, costs and timing of the emissions campaign, including the adequacy of the $396 million remaining accrual.
- Whether elevated inventory and working-capital needs convert to cash as demand and production evolve.
- Exposure to tariffs, China truck-market weakness, currency movements and the projected slowdown in North American oil and gas.
- Final tax effects of the 2017 Tax Act and whether the approximately 21% full-year tax-rate outlook excludes significant discrete items.
- Utilization of the expanded credit facilities, commercial paper balance and execution of announced capital spending and repurchase plans.