Cummins Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 28, 2014 (13 weeks); nine-month period ended the same date (39 weeks). Comparative periods ended September 29, 2013. Unless stated otherwise, dollar figures are in millions.
Business context and financial performance
Cummins designs, manufactures, distributes and services engines, components and power-generation systems worldwide. Its four reportable segments are Engine, Components, Power Generation and Distribution.
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Net sales | $4,890 | $4,266 | $14,131 | $12,713 |
| Gross margin | $1,284 (26.3%) | $1,081 (25.3%) | $3,588 (25.4%) | $3,143 (24.7%) |
| Operating income | $659 | $524 | $1,784 | $1,548 |
| Net income attributable to Cummins | $423 | $355 | $1,207 | $1,051 |
| Diluted EPS | $2.32 | $1.90 | $6.58 | $5.60 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $1,388 | $1,333 |
Q3 sales rose 15%, operating income 26% and attributable net income 19% year over year. Nine-month sales rose 11% and attributable net income 15%. Gross margin improvement reflected higher volumes, favorable mix, lower material and commodity costs, and increased Distribution sales; foreign currency effects and higher warranty costs partly offset gains. SG&A increased, including from compensation, discretionary spending and distributor-acquisition costs.
For the nine months, capital expenditures were $409 million, producing operating cash flow less capital expenditures of approximately $979 million (versus $916 million in 2013). Cash and cash equivalents fell to $2,328 million from $2,699 million at year-end, as financing outflows included $605 million of share repurchases and $370 million of dividends.
Balance sheet, liquidity and capital returns
- At September 28, 2014, total debt including current maturities was approximately $1,689 million; cash, cash equivalents and marketable securities totaled $2,381 million. Debt-to-capital was 17.3%, versus 18.1% at December 31, 2013.
- Current assets were $9,068 million and current liabilities $4,038 million; working capital was $5,030 million and the current ratio 2.25, down from 2.57 at year-end.
- Liquidity included $1.7 billion available under the revolving credit facility, net of letters of credit, plus $271 million available under other facilities. The company expected to seek an extension of its revolver to 2018 on substantially similar terms.
- The board increased the quarterly dividend approximately 25%, from $0.625 to $0.78 per share. A further $1 billion share-repurchase authorization was approved for use after the existing plan is completed.
Material changes and segment trends
- North American on-highway demand was the main growth driver. U.S. and Canada revenue increased 19% in both the quarter and nine-month period; international revenue increased 10% in Q3 and 3% year to date.
- Q3 segment sales and EBIT increased year over year across all four segments. For the first nine months, Engine EBIT increased 13% and Components EBIT 35%; Distribution EBIT increased 19%, while Power Generation EBIT declined 15% and sales declined 6%.
- Distribution growth was substantially affected by consolidating previously partially owned distributors. Nine-month Distribution sales included $662 million from North American distributor consolidations and $171 million of organic growth. Acquisitions also reduce equity income previously recognized from those distributors.
- Distribution EBIT included fair-value remeasurement gains of $18 million in Q3 and $38 million year to date. These acquisition-related gains are unusual and should be distinguished from recurring performance.
- The company revised classification between cost of sales and SG&A to align Distribution reporting with a new performance framework. The reclassification did not affect net income, cash flows or the balance sheet.
Outlook, risks and unusual items
- Management expected strong North American heavy-duty truck demand and continued medium-duty truck and bus share gains for the remainder of 2014. Euro VI emissions requirements were expected to support aftertreatment sales.
- Expected challenges included weak power-generation markets, weak demand in India, continued economic weakness in Brazil and some European markets, possible lax emissions enforcement in emerging markets, and foreign-currency volatility.
- Management planned $650–$750 million of 2014 capital expenditures and expected $150–$200 million of additional spending in Q4 on North American distributor acquisitions. The company also expected full-year 2014 pension contributions of about $205 million.
- Power Generation was considering cost actions that could result in one-time charges of $15–$40 million, potentially as early as Q4 2014.
- The expected full-year effective tax rate was approximately 29.5%, excluding one-time items. Q3’s rate was 34.4%, including a $19 million discrete tax expense; nine-month rate was 30.4%.
- Key exposures include cyclical end-market demand, emissions regulation and product-development costs, customer and supplier concentration, commodity and currency fluctuations, product liability and recalls, pension funding, and execution and integration risks from distributor acquisitions. The filing reports ordinary-course litigation and environmental matters; management did not consider the lawsuits material individually or in aggregate, but cannot assure that final outcomes will not be material.
- Two additional distributor acquisitions closed September 29, 2014, after quarter-end, for total stated consideration of approximately $107 million, subject to customary adjustments; their results were to be included beginning in Q4.
Important facts for investors to verify
- How much of sales and earnings growth reflects organic demand versus distributor consolidation, acquisition gains and changes in equity income?
- Whether North American truck demand remains strong and whether weakness in power generation and international markets worsens.
- Progress against 2014 capital-spending, pension-contribution and distributor-acquisition expectations, including integration costs and margin effects.
- Whether the proposed Power Generation cost actions occur and whether charges fall within the estimated $15–$40 million range.
- Developments in warranty costs and liabilities, tax matters, currency exposure, litigation and environmental contingencies.
- The effect of the revenue-recognition standard scheduled to become effective in 2017; the company was still assessing its impact and adoption method.