Cummins Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter ended September 27, 2015; comparisons are with the quarter ended September 28, 2014. Financial amounts are in millions of dollars unless otherwise stated. Cummins designs, manufactures, distributes and services engines, components and power-generation systems worldwide.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $4,620 | $4,890 | $14,344 | $14,131 |
| Gross margin | $1,208 | $1,284 | $3,735 | $3,588 |
| Operating income | $557 | $659 | $1,828 | $1,784 |
| Net income attributable to Cummins | $380 | $423 | $1,238 | $1,207 |
| Diluted EPS | $2.14 | $2.32 | $6.90 | $6.58 |
| Operating cash flow | Not provided for quarter | $1,131 | $1,388 |
- Q3 sales fell 6%, net income attributable to Cummins fell 10%, and diluted EPS fell 8%. Gross margin was 26.1% versus 26.3%; operating margin was 12.1% versus 13.5%.
- Nine-month sales rose 2%, net income attributable to Cummins rose 3%, and diluted EPS rose 5%. Gross margin improved to 26.0% from 25.4%; operating margin was 12.7% versus 12.6%.
- Q3 weakness reflected lower volumes, unfavorable currency, pricing and mix, and lower investee income; lower material and warranty costs partly offset the pressure. Nine-month results benefited from distributor consolidation, lower material costs, a lower tax rate and lower R&D expense.
Segments and material year-over-year changes
- Q3 segment sales and EBIT: Engine $2,528 and $252; Distribution $1,551 and $123; Components $1,240 and $156; Power Generation $659 and $42. Engine EBIT fell 24%, Components EBIT fell 9%, and Power Generation EBIT fell 30%; Distribution EBIT fell 6% despite 20% sales growth.
- Distribution sales growth largely reflected consolidation of North American distributors acquired since late 2013. These acquisitions also shifted some sales previously reported as external to intersegment sales and diluted Distribution’s EBIT margin.
- International revenue fell 18% in Q3; U.S. and Canada revenue increased 4%. Currency reduced Q3 and nine-month sales by approximately 4%. Major areas of weakness included Brazil, China, Europe, industrial markets, and power generation.
- Nine-month segment EBIT was $846 for Engine, $324 for Distribution, $574 for Components and $148 for Power Generation. Components EBIT increased 10%; Engine and Distribution EBIT declined 7% and 3%, respectively.
Cash, debt and liquidity
- Cash, cash equivalents and marketable securities were $1,723 at September 27, 2015, down from $2,394 at year-end 2014. Nine-month operating cash flow was $1,131; investing cash use was $477 and financing cash use was $1,215. Cash declined $613 overall, including a $52 adverse exchange-rate effect.
- Management attributed the operating-cash-flow decrease from the prior-year period primarily to working-capital outflows of $414, compared with $66 in the prior-year period, partly offset by higher net income.
- Total debt was $1,653, versus $1,698 at year-end; debt was 17.0% of total capital versus 17.3%. Current ratio was 2.23 and working capital was $4,894. The company reported $1.7 billion available under its revolving facility and $197 million under international and other domestic facilities.
- Capital expenditures and internal-use software spending totaled $431 in the first nine months; 2015 planned spending was $650–$700. Cummins repurchased $650 of shares and paid $452 in dividends during the period. The quarterly dividend was raised 25% to $0.975 per share in July.
Outlook, commentary and risks
- Management expected stable North American medium- and light-duty demand, but declining North American heavy-duty truck production, weak power-generation markets, weak oil-and-gas demand, and continued weakness in Brazil, China and some European markets. Foreign-exchange volatility and further mining-market deterioration were additional concerns; management expected challenging conditions to persist for some time.
- Full-year 2015 effective tax rate was expected to be about 29.5%, excluding one-time items; management said reinstatement of the expired research tax credit could reduce it to 28.5%. Full-year pension contributions were expected to be about $175.
- On October 27, 2015, after quarter-end, Cummins announced plans to reduce its worldwide professional workforce by up to 2,000 employees, citing lower demand. It expected a $70–$90 pretax Q4 charge and said facility closures or restructurings could add charges.
- Warranty liability was $1,420. The filing describes ordinary-course litigation, product and environmental claims, and Brazilian labor, tax and customs disputes; Cummins considered pending matters adequately accrued and not material individually or in aggregate, but noted outcomes could adversely affect results. Supplier minimum-purchase arrangements could entail approximately $134 in penalties if purchases ceased; the company did not anticipate penalties.
- Other cited risks include cyclical and slowing markets, emissions regulation, customer and supplier concentration, product recalls and liability, commodity and currency movements, competition, political and compliance risks, pension assumptions, and litigation. The new revenue-recognition standard was scheduled to take effect in 2018; the company was evaluating its impact.
Important facts for investors to verify
- Whether weak industrial, power-generation, oil-and-gas and international demand continued, and whether North American truck forecasts changed.
- How much distributor consolidation contributed to reported sales and whether acquired distribution businesses improved margins over time.
- Whether working-capital requirements, especially receivables and inventories, continued to constrain operating cash flow.
- The realized costs and timing of workforce reductions and facility actions, and any further restructuring charges.
- Developments in warranty costs, supplier commitments, litigation and Brazilian disputes, as well as the tax-credit assumption underlying the full-year tax outlook.