Cummins Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; it is not a standalone fourth-quarter filing. Cummins designs, manufactures, distributes and services diesel and natural-gas engines, components, transmissions and power-generation products. Its four segments are Engine, Distribution, Components and Power Systems. Results benefited from improved demand in North American on-highway markets and several international markets, including China.
Financial performance and liquidity
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $20.428 billion | $17.509 billion |
| Gross margin | $5.090 billion; 24.9% of sales | $4.452 billion; 25.4% of sales |
| Operating income | $2.365 billion | $1.928 billion |
| Net income attributable to Cummins | $999 million | $1.394 billion |
| Diluted EPS | $5.97 | $8.23 |
| Operating cash flow | $2.277 billion | $1.939 billion |
| Cash and marketable securities at year-end | $1.567 billion | $1.380 billion |
| Total debt at year-end | $2.006 billion | $1.856 billion |
| Debt to total capital | 19.7% | 20.6% |
Revenue rose 17%, with all four segments reporting higher sales. Operating income increased 23%; gross margin dollars increased, but gross margin as a share of sales fell 0.5 percentage points. The company reported a 58.0% effective tax rate, versus 24.6% in 2016. Working capital was $3.251 billion and the current ratio was 1.57 at year-end. Capital expenditures were $506 million; the company reported $587 million including internal-use software investments.
Segment sales and EBIT were: Engine, $8.953 billion and $959 million; Distribution, $7.058 billion and $384 million; Components, $5.889 billion and $754 million; Power Systems, $4.058 billion and $294 million. Segment sales include intersegment transactions before eliminations.
Material changes and unusual items
- U.S. tax legislation enacted in December 2017 reduced reported net income by $777 million, or $4.65 per diluted share for the year. The charge included deferred-tax remeasurement, a transition tax on certain foreign earnings and withholding taxes. Tax accounting remained provisional, with possible revisions through the measurement period ending December 22, 2018.
- Excluding the tax-legislation impact, management’s non-GAAP presentation showed net income of $1.776 billion and diluted EPS of $10.62. These supplemental measures are not GAAP and may not be comparable with other companies’ measures.
- Higher volumes, improved leverage and lower material costs supported gross margin dollars. These benefits were partly offset by $264 million of higher warranty costs, including campaigns and estimate changes, and $150 million of increased variable compensation expense.
- Operating cash flow increased by $338 million. The company spent $451 million on share repurchases, paid $701 million in common dividends and invested $600 million for a 50% interest in Eaton Cummins Automated Transmission Technologies. It also acquired Brammo Inc. for approximately $68 million.
- Fourth-quarter 2017 sales were $5.476 billion and gross margin was $1.374 billion; the company reported a $274 million net loss attributable to Cummins and diluted EPS of negative $1.65, primarily reflecting the tax-legislation charge.
Outlook, commentary and risks
For 2018, management expected North American heavy-duty truck demand to improve and medium-duty truck, pickup and construction demand to remain strong. Global mining and construction markets could continue improving, and Brazil might recover. China truck-market demand was expected to decline, while marine markets were expected to remain weak. The filing provides no numerical consolidated revenue or earnings forecast. Management expected a 23% effective tax rate excluding discrete items and planned $730 million to $760 million in capital expenditures.
- Emissions and warranty exposure: Certain pre-2013 engine systems failed additional EPA and CARB testing due to aftertreatment-component degradation. A $29 million field-campaign charge was recorded in 2017, but the affected population and total financial impact were not yet determined; a material impact remained possible. The company did not then expect EPA or CARB fines or penalties for this matter.
- Customer and market concentration: PACCAR represented 14% of 2017 sales, and four major OEM customers together represented 33%. Cyclical markets, customer financial distress and customers’ potential shift to in-house engine production could adversely affect results.
- Investee dependence: Cummins recorded $357 million of equity, royalty and interest income from investees; more than half of that income came from three 50%-owned China joint ventures that Cummins does not control unilaterally.
- Other risks: The filing highlights changing emissions rules, electrification and other technology shifts, supply-chain disruptions, foreign exchange and commodity volatility, litigation and product liability, cyber risk, pension assumptions and international trade or political changes.
Management described liquidity as strong, with access to revolving facilities and $1.567 billion of cash and marketable securities. The company reported compliance with debt covenants. The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded those controls were effective at year-end.
Most important facts for investors to verify
- Final measurement-period adjustments to the provisional tax-reform amounts and their cash-tax timing.
- Scope, remediation cost and regulatory outcome of the aftertreatment degradation issue, including any further campaigns or affected engine populations.
- Whether expected 2018 market conditions, particularly China truck demand and mining and construction activity, matched management’s outlook.
- Progress, profitability and impairment risk for the Eaton Cummins transmission joint venture and Brammo-related electrification investments.
- Warranty-liability development, cash conversion and planned capital spending, dividends and repurchases.